Agency2 min read
Contractor or employee? Classification risk for agencies
Agencies are built on contractors. Some of those contractors work only for you, on your schedule, with your accounts, and have done for two years — and those are employees in fact, whatever the agreement says.
Published
The freelance bench is what makes an agency's cost base flexible. It is also the largest unpriced liability most agencies carry, because the paperwork saying someone is a contractor is not what decides whether they are one.
What the tests look at
The federal analysis and the various state ones differ in structure but converge on control: who decides how, when and where the work is done. Several states apply a considerably stricter standard than the federal one, under which a worker is presumed an employee unless specific conditions are all met — including that the work falls outside the usual course of the hiring business.
The signals that matter
| Points toward contractor | Points toward employee |
|---|---|
| Several clients | You are their only client, and have been for years |
| They set their own hours | Fixed shifts or required availability |
| Their own equipment and software | Your laptop, your subscriptions, your accounts |
| Paid per project or deliverable | The same amount every month regardless of output |
| They can send a substitute | It must be them |
| They market their own services | They are introduced to clients as part of your team |
What the exposure is
- Back employment taxes, plus interest and penalties, for the periods concerned.
- State-level exposure — unemployment insurance and workers' compensation contributions, and in some states penalties of their own.
- Wage and hour claims, including overtime for periods where the person was in fact an employee.
- It compounds silently. A misclassification running for three years is three years of exposure discovered at once, usually because a worker filed for unemployment.
Practical management
- Audit the bench annually. Sort by tenure and by share of their income. The long-tenured exclusive contractors are the risk.
- Fix the relationship, not the paperwork. Genuine flexibility, their own tools, project-based scope.
- Or employ them. For someone who has been full-time for two years, employment is often cheaper than the exposure and better for retention.
- Contracts plus tax forms are the floor. A signed agreement and a W-9 or W-8BEN are necessary and nowhere near sufficient.
- Overseas contractors are a different question, not an absent one. US classification rules generally do not reach them, but their own countries' rules do, and sufficiently embedded staff can raise permanent-establishment issues.
One thing not to do: rely on the contractor's preference. Many freelancers prefer contractor status and will say so. Their preference is not a defence, because the taxes at stake are not only theirs.
Get the company structure right underneath
Founders 8 holds the entity, the filings and the deadlines so the attention goes to the questions that need judgement.
Build your workspaceThis is one section of the agency structure guide, which covers the entity choice itself.
Founders 8 tracks obligations and deadlines for your reference. It does not provide legal or tax advice — filings are prepared and reviewed by qualified partners.