Employee or Independent Contractor - A Few Guidelines

The Wall Street Journal recently reported something that most business owners already know or should know, that "there is a crackdown on businesses that treat some workers as independent contractors and its causing a stir in industries from trucking to exotic dancing.”  It’s not that the government has anything against exotic dancers or truckers.  The issue for the government is that when employees are misclassified, employees do not get the benefits and overtime to which they are otherwise entitled and the employers avoid paying payroll taxes, i.e., lower revenues for the government.  Independent contractors (ICs) can be referred to as freelancers, consultants, contractors, project workers, temps, specialists, etc.  They are in every industry because, at least on paper, they often make good business sense for many companies.  So how do you know if your workers, whether truckers, dancers, technicians, etc., are employees or independent contractors?

Fortunately, state governments (click here for New York), the Department of Labor (DOL) and the Internal Revenue Service (IRS) provide guidelines.  This might seem like a lot of factors to keep up with but these questions/factors really focus on the same few areas that are concentrated quite nicely in the IRS Three Prong Test.  The IRS divides its analysis into three areas: financial control, behavior control, and the type of relationship.  The analysis focuses on an overall review of the business/worker relationship, who controls the worker, and how the work is performed.

• Financial Control - Are the business aspects of the worker’s job controlled by the company (these include things like how worker is paid, whether expenses are reimbursed, who provides tools/supplies, etc., the extent to which the worker can realize a profit or loss)?
• Behavioral Control - Does the company control or have the right to direct and control what the worker does and how the worker does his/her job through instructions, training, or other means?
• Type of Relationship - Are there written contracts or employee type benefits (i.e. pension plan, insurance, vacation pay, etc.)? Will the relationship continue, i.e., open-ended or project based and is the work performed a key aspect of the business?

The IRS provides more detail on behavioral control in its 20 Factor Right to Control Analysis. 

The Fair Labor Standards Act/DOL applies an "economic realities test" where the analysis, similar to the IRS seeks to determine the totality of the worker/company relationship.  

• Control of Work - The degree to which the company controls the manner in which the work is performed;
• Opportunity for Profit or Loss - The worker's opportunity for profit or loss depending upon the worker's managerial skills;
• Investment by Worker - The worker's investment in equipment or materials required for this project or the worker's employment of helpers;
• Use of Judgment - Whether the services being rendered require a special skill and use of initiative/judgment;
• Permanence of the Relationship - Work for fixed period of time or discrete project
• Integration into Company's Business - Whether the service rendered is an integral part of the alleged employer’s business.

Risks of Misclassification

Risks include liability for unpaid federal, state and local income tax withholdings and Social Security and Medicare contributions, unpaid workers’ compensation and unemployment insurance premiums, and even unpaid work-related expenses and overtime compensation. Any these types of liabilities (in addition to interest and penalties for non-compliance) can be devastating for most businesses. 

The better course is to avoid misclassification.  

Thinking about hiring Independent Contractors?

• Prepare a written agreement for independent contractors addressing terms of the project/assignment.
• Set start and completion dates for the project.
• Make it clear that the worker is free to work for other companies.
• Compensate for the work performed, not the time required to do the job.
• Avoid providing office space, computers, tools and equipment.
• Have workers remain responsible for their own insurance and training.
• Don’t treat the workers as employees (i.e., don't provide business cards and employee perks).

If you think that you have misclassified workers or have any questions, contact me or visit my website.