How Independent Contractors Are Different from Employees and Why You Should Care

For Colorado business owners, classifying workers correctly is more than just a formality—it’s a legal and financial imperative. Misclassifying an employee as an independent contractor can expose a business to back taxes, penalties, and even litigation. But what’s the actual difference between the two categories, and how does Colorado and federal law determine the line? This article breaks it down so you can protect your business from costly mistakes.

What Is an Independent Contractor?

An independent contractor is a person or business hired to perform specific work or services without being under the direct control and supervision of the hiring party. Unlike employees, contractors control how and when the work gets done, typically use their own tools, and are often engaged for a particular project or timeframe.

Employees, on the other hand, are generally hired for ongoing work and are subject to the day-to-day direction of the employer. The employer withholds taxes, provides benefits, and is responsible for complying with labor laws covering wages, discrimination, and workplace safety.

Legal Tests and Tax Implications

Both state and federal agencies use multi-factor tests to determine whether a worker is an employee or an independent contractor. The IRS primarily looks at the degree of control and independence in the relationship, examining behavioral, financial, and relational aspects of the arrangement. If the business controls how the work is performed, or provides significant tools and benefits, the worker is likely an employee.

Colorado law follows a similar framework, with a presumption that workers are employees unless proven otherwise. To rebut that presumption, the employer must demonstrate that the worker is both free from control in how the work is performed and engaged in an independent trade or business. A written contract can help shift the burden of proof, but the agreement must be clear, contain required disclosures (including that the contractor is responsible for their own taxes and not entitled to unemployment insurance), and be properly executed—often with notarization.

Tax-wise, businesses are not required to withhold income taxes or pay Social Security, Medicare, unemployment insurance, or workers’ compensation premiums for independent contractors. Those obligations shift entirely to the worker. This can result in significant cost savings, but also carries risk if the classification is incorrect.

Consequences of Misclassification

If a business incorrectly classifies an employee as a contractor, it may be liable for back taxes, penalties, and unpaid benefits. The IRS and Colorado Department of Labor and Employment may also assess fines and interest. Additionally, the worker may sue for unpaid wages, overtime, or denied benefits. However, businesses may avoid penalties if they had a “reasonable basis” for the classification—such as relying on a prior IRS audit, industry norms, or legal advice.

At the federal level, classifying an employee as an independent contractor with no reasonable basis for doing so makes the employer liable for the amount of state and federal taxes that should have been withheld from the laborer’s pay, as well as the amount that should have been contributed to welfare programs such as unemployment and worker’s compensation. Certain employers that can provide a reasonable basis for not treating a worker as an employee may have the opportunity to avoid paying employment taxes.

To establish that you had a reasonable basis for not treating the workers as employees, you can show that:

·       You reasonably relied on a court case about federal taxes or a ruling issued to you by the IRS; or

·       Your business was audited by the IRS at a time when you treated similar workers as independent contractors and the IRS did not reclassify those workers as employees. You may not rely on an audit commenced after December 31, 1996, unless such audit included an examination for employment tax purposes of whether the individual involved (or any other individual holding a substantially similar position) should be treated as your employee; or 

·       You treated the workers as independent contractors because you knew, and can substantiate, that was how a significant segment of your industry treated similar workers; or

·       You relied on some other reasonable basis. For example, you relied on the advice of a business lawyer or accountant who knew the facts about your business.

Publication 1976 PDF, Section 530, Employment Tax Relief Requirements

Independent Contractors in Colorado: Special Requirements

Colorado adds specific legal obligations for properly classifying independent contractors. A valid contract must show that the contractor is free from control and customarily engaged in an independent business. The contract must also contain a disclosure—in bold or otherwise conspicuous text—stating that the contractor is not entitled to unemployment benefits and is responsible for their own taxes.

In certain industries, like construction or trades, contractors may need additional licenses or insurance coverage. Independent contractors must also maintain their own tax records, make quarterly estimated tax payments, and carry liability or workers’ comp insurance if applicable.

Can an Independent Contractor Get Unemployment or Workers’ Compensation Benefits?

Unfortunately, because employers do not contribute into unemployment and workers’ compensation insurance funds by withholding portions of wages for independent contractors, those independent contractors cannot claim any of those funds if they get hurt on the job or laid off.

It is important to know that there is a presumption that employed individuals are employees as opposed to independent contractors. To prove an individual is an independent contractor, they and the person for whom services are performed must show by a preponderance of the evidence that the individual is free from control and direction in the performance of the service. While the parties may prove independence through a document, i.e., contracting agreement, all signatures on any such document must be notarized. The contract must also contain a disclosure in bold, underlined, or large font that the contractor is not entitled to unemployment insurance benefits and must pay state and federal taxes on any compensation paid pursuant to the agreement.

An employer should have a complete and accurate understanding of all facts surrounding the relationship between the employer and the worker, so they can meaningfully apply the various factors used to determine a worker’s classification. GLO will help you determine your worker’s status, so they are classified according to your needs.

How GLO Can Help

Geraghty Law Office works closely with Colorado business owners to prevent costly classification mistakes and ensure employment relationships are clearly defined and legally sound. We assist in drafting and reviewing independent contractor agreements that comply with both federal and state laws, including the specific language and disclosures Colorado requires. If you're uncertain how to classify a worker, or you’ve already received notice of an audit or legal claim, we provide strategic guidance to minimize exposure and navigate disputes. Whether you’re hiring for a short-term project or building out your team, GLO helps you structure your workforce in a way that protects your interests and keeps your business compliant. To learn more about how GLO can help, visit Colorado Independent Contractor Agreements: Legal Requirements and Practical Guidance.

Please fill out an Intake Form to inquire about working with GLO.

GLO has prepared this blog to provide general information on legal issues that may be of interest. This blog does not provide legal advice for any specific situation and this does not create an attorney-client relationship between any reader and GLO or its attorneys. GLO engages clients only through specific signed fee agreements. GLO does not guarantee any results.

EXPLORE OUR CLIENT REVIEWS

Take a moment to read what our clients have said about their experience working with GLO.