It’s tough having employees these days. Between payroll taxes, benefits, insurance, and an ever-expanding set of employment laws to navigate, some employers might be tempted to forget it all and simply designate their workers as independent contractors. As long as the company calls the worker an independent contractor, and he or she agrees to the arrangement, that’s enough, right?
Wrong. As many unfortunate employers have discovered, few decisions have such costly and unpleasant consequences for businesses as misclassifying an employee as an independent contractor. Employers who misclassify employees can be liable for back wages, unpaid benefits contributions, unpaid unemployment insurance contributions, and unpaid workers compensation premiums, not to mention a host of tax liabilities, penalties, and fines. And if you think your clients’ businesses are unlikely to become government targets, think again. The Obama administration has made a well-publicized effort to crack down on worker misclassification, resulting in additional funding for the Department of Labor (DOL) and a higher number of investigators pursuing noncompliant employers. The DOL has also entered into information-sharing agreements with the Internal Revenue Service (IRS) and officials in several states, ensuring that an increasing number of employers will be subject to scrutiny.
So how do you determine if a worker is properly classified as an employee or an independent contractor? The detailed answer is that unfortunately, it depends. State and federal agencies, including the IRS and its state counterparts, have different tests for determining independent contractor status, not to mention common-law tests that affect issues such as tort liability. But all hope is not lost. Despite the varying tests, there are some common attributes of any successful independent contractor relationship.
Generally, employers should analyze the degree of control they have over the worker, and the independence of the worker. The IRS lumps facts relevant to these considerations into three categories: (1) behavioral control, (2) financial control, and (3) type of relationship. Behavioral control refers to the employer’s right to control the manner and method in which the worker performs the work. If a worker receives detailed instructions concerning when and where to perform the work, what tools to bring, who can assist, and the sequence in which the work should be performed, he or she is probably not an independent contractor. Nor is independent contractor status likely if the worker is evaluated on the process of performing the work, or is provided training on how to do the job.
Financial control refers to whether the worker has the right to control the economic aspects of his or her job. An independent contractor makes a “significant investment” in his or her business in the form of tools and other equipment, has the opportunity to make a profit or loss in light of that investment, is free to work for other businesses in addition to the employer’s, and may not be paid at an hourly rate.
Type of relationship refers to the manner in which the worker and employer perceive their relationship. An independent contractor typically works according to a written contract, does not receive benefits, works for a specific period of time (as opposed to indefinitely), and does not provide services that are a key aspect of the business (for example, a production worker at a production facility).
With these guidelines in mind, employers who want to ensure independent contractor status for their employees should take the following steps.
Get a written agreement. All independent contractors should work under a written agreement that discusses the considerations above, including the independent contractor relationship, the job to be performed, the terms of payment, and the term of the agreement.
Don’t treat independent contractors like employees. Independent contractors should not receive the same employee handbook or training as employees, nor should they be entitled to perks such as health insurance and vacation time. At the end of the year, independent contractors should receive a Form 1099, not a W-2.
Conduct a check-up. Employers should frequently audit their workforce to ensure that workers are properly classified according to the guidelines above, making adjustments and consulting counsel as necessary.
Employers who have already misclassified workers may also have the option of participating in the IRS’s Voluntary Classification Settlement Program, which provides some relief from past-due federal employment taxes as the employer prospectively designates misclassified independent contractors as employees.
With enforcement showing no signs of slowing, there’s no time like the present for employers to examine their workforce and make sure everyone is properly classified—before government officials come knocking.