The terms subcontractor and independent contractor are often confused or misused. To protect yourself and your business from risk, it’s important to know the key differences and how your dealings with each should be structured.
What is an independent contractor?
An independent contractor is a self-employed individual (in other words, a non-employee) who provides goods or services on an “as needed” basis to an employer, per a written or verbal agreement. The independent contractor agreement typically spells out exactly what will be provided in exchange for a set amount of money. For example, if you hire your neighbor to mow your lawn for $50, you have employed them as an independent contractor.
A primary component of being an independent contractor is self agency—they set their rates, choose how to spend their time, and decide how to complete the task assigned to them. Using the previous example, it would be up to your neighbor to decide whether to use a riding or push lawn mower. Additionally, he could cut the lawn at 2:00 p.m. or 3:00 p.m. because there are no set work hours.
Defining the role of an independent contractor becomes more complicated when the work involves bigger, long-term projects. It gets particularly complex in the construction world, which regularly employs both contractors and subcontractors.
What is a subcontractor?
In many industries, such as construction, a general contractor oversees a large job and divides it into smaller tasks, delegating the work to other individuals. Subcontractors are frequently the individuals who assume responsibility for these tasks. While they are not officially an employee of the contractor, they are employed by the contractor. While subcontractors often take on a role very similar to an independent contractor, there are a few important differences.
Unlike with an independent contractor, the subcontractor has no direct relationship with the individual or business that “owns” the larger project. The contractor hires and pays the subcontractor directly for specific parts of the project. In many instances, the individual or business doesn’t know who the subcontractor is and does not have a legal obligation to pay the subcontractor.
For example, if a homeowner hires a general contractor to renovate their house, the homeowner will rarely know who is subcontracted to handle the plumbing. If the contractor fails to pay the plumbing subcontractor for the work completed, the subcontractor would address the issue—and potentially sue—the contractor, not the homeowner.
What is the main difference between a subcontractor and an independent contractor?
The role of subcontractor and independent contractor is the same in the sense that both exchange a specific amount of money for a specific task, and do not formally enter into a master/servant relationship as recognized by the law. The main difference lies in who isemploying the person. If a worker is employed by a company directly, they are an independent contractor. If the worker is hired to perform a specific task for a general contractor, they are a subcontractor.
Does my workers compensation policy cover independent contractors and subcontractors?
Typically, your workers compensation policy does not cover independent contractors or subcontractors. Most states require workers compensation coverage for employees only. This can get complicated when your relationship with a subcontractor shifts to the point that your state legally considers them an employee, even if the IRS does not. If your subcontractor or independent contractor should be classified an employee per state law, you now have an obligation to provide workers compensation coverage for them.
In some states, general contractors are responsible for the workers compensation claims of an uninsured subcontractor. This depends on your state of residence, so we suggest looking up your local statutes.
How do I know if my independent contractor or subcontractor has legally shifted to an employee?
This is a complicated question often litigated by courts. The answer depends on your state’s laws, but you can expect a few factors to be universally considered:
The degree of control exercised by the employer
The degree of independence exercised by the subcontractor/independent contractor
How many people the independent contractor/subcontractor works for
The method of payment to the independent contractor/subcontractor
The right of either party to terminate the agreement
Do I have any legal obligations to my subcontractors and independent contractors?
While this can depend on your state’s laws and the circumstances, the short answer is yes. In some instances, you may have a legal obligation to a subcontractor if they are injured on the job and do not have workers compensation insurance. One way to protect yourself from this situation is to require that all subcontractors provide you with proof of workers compensation coverage.
What are other insurance ramifications when using independent contractors or subcontractors?
Using subcontractors and independent contractors can affect not only the number of insurance companies that will provide you with coverage, but the quality of coverage you can purchase. If a significant portion of your labor is performed by independent contractors, you will likely be viewed as a general contractor by an underwriter, which means you are much more limited on insurance options due to the increased risk levels.
For example, a flooring contractor with a team of employees who uses the occasional independent contractor might be able to secure excellent coverage on general liability quotes from five different insurance companies. But a flooring contractor who exclusively hires independent contractors might have a quote from one insurance company that is double the price, with more exclusions.
In addition to the pricing and coverage considerations, you have to be very diligent about making sure your independent contractors and subcontractors have their own insurance and provide you with certificates of insurance. If they don’t have coverage, you end up paying for their insurance on your policy once the audit is complete.
The Bottom Line
While hiring independent contractors or subcontractors can help you obtain the resources and skill sets you need, and lower business costs, it can also lead to a legal nightmare if you don’t have proper insurance. We recommend contacting your insurance professional to ensure that you’re covered under your policy, or take steps to ensure your subcontractors are adequately covered.