Contractor vs. Employee in Functional Medicine: Avoiding Misclassification Risks

Functional medicine practices operate at the intersection of patient care and business management. One area that requires careful attention is worker classification. If a clinic treats someone as a contractor when they legally qualify as an employee, the result can be penalties, back taxes, denied claims, and reputational harm.

The choice between contractor and employee status isn’t just about payroll. It shapes how care is delivered, how workflows are managed, and how liability is shared. Contractors may provide flexibility and reduced overhead, while employees can bring consistency and greater integration into clinical systems.

This article outlines considerations that help clinics determine worker status in a safe and compliant way. It explains how regulators assess classification, what the implications are for daily operations, and what steps practices can take to reduce risk.

Core definitions and clinical impacts

Before exploring legal frameworks and compliance, it’s important to clarify what contractors and employees are, and why the distinction matters in functional medicine clinics.

Independent contractor

An independent contractor is considered self-employed. They generally work under a contract for specific services, often within a limited scope or timeframe. They typically supply their own tools and handle their own tax obligations.

Common characteristics include:

• Autonomy in deciding when and how work is performed
• Payment based on projects, deliverables, or service fees
• Responsibility for business expenses and insurance coverage
• Ineligibility for clinic-provided benefits such as health insurance or retirement plans

In a healthcare setting, contractors may be used for specialized consulting, part-time services, or tasks that aren’t central to the clinic’s daily operations.

Employee

An employee is directly hired by the clinic and integrated into its systems. Employees generally follow clinic policies, use clinic tools, and are paid through regular payroll.

Employees usually:

• Work under the direction of clinic leadership
• Receive consistent pay, either hourly or salaried
• Use equipment and technology provided by the employer
• Qualify for employment protections and, in many cases, benefits

Clinical implications

Classification decisions have an impact on patient care. Contractors can provide flexibility but may not be as deeply involved in quality assurance or care coordination. 

Employees, on the other hand, are typically more consistent participants in clinical protocols and patient continuity. Over-reliance on contractors in roles that closely mirror employees may raise compliance questions under labor law and payer policies.

Legal frameworks and tax obligations

Worker classification isn’t based on preference but on how the relationship functions in practice. Regulators review the level of control, financial arrangements, and the overall nature of the work.

Classification tests

In the United States, the Internal Revenue Service (IRS) applies a test based on behavioral control, financial control, and the type of relationship.

Some states, such as California, use the ABC test, which assumes workers are employees unless all three conditions of independence are met.

In Canada, the Canada Revenue Agency (CRA) applies a four-part test that looks at control, ownership of tools, financial risk, and integration into the business.

Documentation

Proper documentation is part of compliance. Contractors often complete W-9 forms in the U.S. or submit invoices in Canada. Employees complete W-4 and I-9 forms in the U.S. or are issued T4 slips in Canada. If a role is unclear, clarification forms such as IRS Form SS-8 or CRA Form RC4110 may be used to request a determination.

Tax responsibilities

Employers are responsible for withholding and remitting payroll taxes for employees, including Social Security or Canada Pension Plan (CPP) contributions and unemployment insurance. 

Contractors manage their own self-employment taxes and aren’t eligible for unemployment coverage or employer-sponsored benefits. If regulators determine a worker has been misclassified, the clinic may be responsible for unpaid taxes, penalties, and retroactive contributions.

Operational control and workflow considerations

Legal definitions are important, but day-to-day operations often reveal whether a role looks more like a contractor or an employee.

Supervision and oversight

Employees are usually directed by clinic management, attend staff meetings, and may receive evaluations. Contractors generally complete agreed tasks independently without the same level of oversight.

Nature of work

Employees often provide core, ongoing services such as patient care coordination or intake management. Contractors are more suited to short-term or specialized projects, for example, IT support or a guest lecture series.

Integration

Workers who are integrated into clinic systems, branded as part of the team, or given access to full EHR systems are often considered employees by regulators. Contractors are typically kept more separate.

Risk and insurance

Employees are normally covered by employer-provided protections such as workers’ compensation. Contractors are expected to carry their own coverage, but liability can still reflect back on the clinic if roles aren’t clearly defined.

Privacy and technology

Providing contractors with broad access to patient systems or telehealth platforms can suggest an employee relationship. If contractors are granted access, practices should have clear agreements and safeguards in place to comply with privacy regulations.

Managing compliance and preventing misclassification

To reduce risk, practices should actively monitor how roles are structured and documented. A proactive approach helps avoid audits and penalties.

Warning signs of misclassification

Certain practices can signal misclassification, such as:

• Setting fixed daily hours for a contractor
• Providing all tools and equipment needed for the role
• Including a contractor in employee benefits programs
• Reviewing contractor performance as if they were staff

Contracts and agreements

Contracts with contractors should:

• Define specific deliverables and payment terms
• Clarify tax and insurance responsibilities
• Avoid language that implies the clinic controls daily activities

Ongoing review

Arrangements should be reviewed regularly. If a contractor begins to take on responsibilities that resemble employee work, a shift in classification may be necessary. Documentation such as contracts, invoices, and supervision notes should be maintained to support compliance if reviewed.

Jurisdictional considerations and billing implications

Regulations and payer rules vary, so clinics must consider both local laws and financial consequences when determining worker status.

U.S. federal and state rules

The Fair Labor Standards Act, IRS rules, and Department of Labor guidance set the federal framework. States may add stricter tests, so clinics should review local regulations. Penalties for misclassification can include back wages, unpaid taxes, and fines.

Canadian framework

In Canada, misclassification can lead to retroactive CPP and Employment Insurance contributions. CRA reviews control, financial risk, and integration when determining worker status.

Billing and credentialing

Some insurance payers only reimburse for services delivered by credentialed employees. Contractors may not be billable under certain agreements, which can create financial risk if classification is incorrect.

Role-specific considerations

Different roles in a functional medicine clinic may require different classification approaches.

Physicians may work as contractors if they maintain autonomy and provide their own coverage, but arrangements should be structured carefully.

Therapists, coaches, and allied health providers are sometimes misclassified when they are integrated into clinic branding or supervision. In many jurisdictions, this points toward employee status.

Administrative staff with scheduled responsibilities and access to core systems are usually considered employees. Contractors in these roles often raise compliance concerns.

Frequently asked questions (FAQs)

Many clinics have recurring questions about worker classification. Below are explanations to help clarify common points of confusion.

What’s the difference between a contractor and a per diem employee?

A per diem employee is still legally classified as an employee, even though their hours may vary or be limited. They remain under clinic oversight, are included in payroll, and may qualify for protections or benefits depending on jurisdiction. Contractors, by contrast, operate as self-employed individuals and aren’t treated as staff.

Can someone be both a contractor and an employee?

In some situations, a person may serve in both capacities, but this is often complex. If the roles overlap significantly, regulators may decide the person should be treated as an employee. Clinics should structure such arrangements with caution and seek legal or accounting input.

Do tax forms decide worker status?

No. Submitting tax forms is required, but worker status is determined by how the relationship functions in practice. Regulators focus on control, integration, and financial risk rather than paperwork alone.

What happens if regulators reclassify a worker?

If a regulator determines a worker has been misclassified, the clinic may be required to pay back taxes, penalties, and potentially retroactive benefits. This can also affect payer relationships and insurance billing.

Can a contractor become an employee?

Yes. A contractor may transition into an employee role, but this requires updating contracts, moving the worker to payroll, and ensuring compliance with employment law. The transition should be well-documented.

Are there insurance billing limitations for contractors?

Yes. Some payers and insurance plans only accept billing from credentialed employees. Contractors may not be billable in certain systems, so this must be verified before services are provided.

What about privacy risks with contractors?

Granting contractors access to patient records or telehealth systems carries compliance responsibilities. Clinics should set clear limits on access, use confidentiality agreements, and ensure safeguards are in place.

Who owns the work created by contractors?

Ownership depends on contract terms. Without clear language, disputes can arise over intellectual property such as educational materials or digital resources. Best practice is to clarify ownership in writing before work begins.

How can a clinic reduce misclassification risk?

Clinics can reduce risk by reviewing each role against classification tests, maintaining clear contracts, conducting periodic audits, and consulting qualified professionals when necessary.

Key takeaways

• Worker status is determined by how the relationship operates in practice, not just by labels or forms.
• Contractors typically manage their own work, taxes, and insurance, while employees are integrated into clinic systems and benefit from employment protections.
• Misclassification can lead to penalties, back taxes, denied claims, and reputational risks for clinics.
• Written contracts and accurate documentation are essential to clarify roles and reduce the likelihood of disputes.
• Roles should be reviewed regularly since responsibilities may shift over time, changing the appropriate classification.
• Professional guidance from legal or accounting experts is advisable when roles are complex or uncertain.

Disclaimer:

This content is for educational purposes only and is not legal, tax, or compliance advice. Regulations vary by jurisdiction. Clinics should consult qualified professionals before making decisions about employment classification.