There are so many important legal issues that hinge on the distinction between the independent contractor verses the employer/employee relationship. It is essential that employers realize these issues before embarking on the hiring of an independent contractor, an agent or employees.
A number of workers these days prefer to trade in the corporate hierarchy for the freedom to be their own boss. Child care, elder care, commuting, and work life balance are all reasons why employees are choosing to contract rather than seek employment with one employer as a fulltime employee. These independent contractors can be found in nearly every profession, from lawyers and business consultants to writers and Human Resource consultants. They set their own schedule and enjoy a wide variety of work experiences.
The independent contractor arrangement can benefit both workers and businesses. However, a company that misclassifies its workforce as independent to avoid paying payroll tax or providing benefits, could be liable for the uncollected payroll taxes, interest and penalties. Regular status employees are entitled to certain legal protections and benefits that independent contractors are not — and the IRS and state governments are actively looking for clues that a company might be misclassifying the workers.
There is a continued need for companies to reduce costs – inevitably, payroll jumps to the top of the list of areas to reduce expenditures because it is often one of the largest costs an organization has, which usually results in the layoff of staff. However, employers are still faced with the need to have work or projects completed. Many companies choose to use laid off employees as independent consultants to do work on an as needed basis. There are risks involved with converting staff to consultant status verses changing the employee status to part-time.
There is always risk when an employee is changed to independent contractor status especially if it is within the same tax year. If the employee receives both a W2 and a 1099 for the same year from the same employer then it throws up a red flag to the government agencies and could possibly trigger an audit.
If the agent is doing the same job they did as an employee and they are then reclassified as independent contractor it may invoke state and federal agencies to get involved to determine the agents true status.
As an alternative, the employer may change the employees status to part-time rather than independent. The advantages of converting a former employee to part-time rather than an independent contractor include:
- Reduce or eliminate the red flag to multiple agencies that could trigger an audit, fines, and penalties.
- Less administrative work – when an employee is converted to an independent contractor they must be issued a W2 and 1099 at the end of the year.
- Employee can still apply for unemployment insurance as a part-time employee.
- Employees may still be eligible for company benefits or COBRA.
- No risk of an uninsured independent contract for liability or workers compensation.
An independent contractor qualifies as an agent – or employee – when the following standards are met:
- The degree the principal directs the work of the independent contractor. The more direction, the more likely it is an employee. This is by far the most important factor in determining the relationship as either independent or employer/employee.
- The condition which the independent contractor may be terminated. An independent contractor should not be fired unless contractual obligations are not met.
- The legal obligations of the worker. An employee may not legally be obligated nor experience undue repercussions for doing incorrect work or violating policy. Whereas an independent contractor may incur civil liabilities for such.
- The assistants are subject to control of the employer. If the independent contract has assistants or subagents helping him perform the duties of the contract, they should be employees of the independent contractor and not under the control of the employer.
- How the independent contractor is paid. Independent contractors should be paid on a per job basis and not on a salary or hourly basis.
- Training provided by the employer. Independent contractors are considered highly skilled in their trade and should possess the expertise needed to complete the project without the need for training by the employer.
- An independent contractor is distinguished from the employer’s regular employees. An independent contractor should not be doing normal everyday operational duties.
- Independent contractors should schedule their own work. If the employer dictates that the worker arrive at a certain time, take lunch at a certain time, and conclude their day by a certain time, there is more than likely an employer-employee relationship.
- The independent contractor should furnish their own tools. Independent contractor’s should not have a company email address, company business cards, company cell phone, or other tools and equipment that belong to the employer,
- The independent contractor provides services to more than one employer or organization. If the contract restricts the worker from offering services to other parties or the independent contractor works exclusively for one employer, it may be found they are employer-employee relationship.
A service provider can legitimately be an independent contractor if he has real autonomy and the opportunity to make a profit by exercising his own business judgment and discretion.
There are employees who want the independence of being their own boss and setting their own schedule and then there is the independent contractor who wants the benefits of an employee – paid leave, benefits, retirement, overtime, etc… Both the worker and the employer need to follow the control test to determine the correct classification.
Often an individual will accept the contract relationship because they have been unable to secure regular status employment. Since these individuals are not truly independent contracts they are often ignorant of their legal duties to pay employment tax or the inability to collect unemployment insurance. There can be legal and tax consequences for the independent contractor who hasn’t paid their taxes including Social Security and Medicare taxes, or carry the proper insurance which now includes health care. When the independent contract faces tax penalties or wants the benefits provided by an employment relationship, they often will file suit to claim their right to the employer’s benefits which may include health care coverage, retirement plans, disability insurance and workers compensation.
You can learn more about the determination of a worker’s status as an Independent Contractor or Employee at IRS.gov by selecting the Small Business link. Additional resources include IRS Publication 15-A, Employer’s Supplemental Tax Guide, Publication 1779, Independent Contractor or Employee. These publications are available on the IRS Web site or by calling the IRS at 800-829-3676 (800-TAX-FORM).
Barbara Trumbly, SPHR, SHRM-SCP
Director, HR & Client Services
Centricity Solutions, Inc.