Here at the height of the “gig economy”, when almost 8.4% of the workforce is made up of independent contractors, knowing the difference between an employee and an independent contractor is essential for business owners everywhere. Determining how to treat the payments you as a business owner make for services can be very complicated and rely on a vast range of variables.
This Is Too Complicated – Why can’t I call everyone an independent contractor and let them pay their own taxes?
This may seem like the easy answer, especially since the government is getting the full self-employment tax from the employee. However, that is not the case. The government’s perspective is to ensure that businesses, even small ones, do not take advantage of workers. If everyone is an independent contractor, then you would not have to pay minimum wage, overtime, or worker’s compensation benefits. Because the IRS talks with OSHA, the Department of Labor, and state government offices dealing with unemployment and worker’s compensation benefits, the helpful folks at the government are going to know if you are properly classifying someone or not. While the non-payment of taxes is not the main driver behind an audit – a request for unemployment compensation or worker’s compensation benefits usually are – you run the risk of owing a lot of money in back taxes – you become responsible for the unpaid 7.25% of FICA taxes, and any unemployment taxes owed to the state, along with penalties that can be more than 100% of the taxes owed.
I Make Everyone Sign a Contract Saying That They are an Independent Contractor… Isn’t That Good Enough?
While having service providers sign a document indicating that they are an independent contractor is a good start, it is not a full-proof way of protecting yourself. In fact, depending upon what is included in the contract, it could be used against you to show that the person is actually an employee. For instance, if your contract sets the wage on an hourly basis, and your contract has a non-compete clause, odds are that the government will use that to support their position that the individual is an employee as opposed to an independent contractor. This is because you pay employees by the hour, and contractors by the job; and in order to be an independent contractor, one needs to be free to compete in the market-place for work – even against those businesses that they do work for.
My Business is Cyclical in Nature, Doesn’t That Mean Everyone is a Contractor?
While using independent contractors to help unexpected surges in work is a smart business move, just because your business runs in cycles does not mean that everyone is an independent contractor. You need to keep in mind, especially in the day and age of the Affordable Care Act, that the number of full-time employee equivalents governs whether you must provide care. Because of this, and because the government does understand that certain types of businesses are subject to seasonal cycles – can anyone say lifeguard, or ski patrol – there are special rules that govern these seasonal employees. Other types of businesses need additional temporary workers to get through a busy season – a lot of businesses hire extra employees during the Christmas shopping season. In both of these situations, the folks are employees, not independent contractors. While you may find yourself in a unique situation, most often that additional help will be classified as an employee, even if they are only temporary or seasonal in nature.
What Happens if I Now Realize that Someone is Misclassified?
If you classify an employee as an independent contractor incorrectly, there can be serious legal ramifications. An audit or lawsuit can cost you in the form of back pay, overtime, meal breaks, and more, to the tune of thousands of dollars per employee, in addition to penalties and interest for the incorrect classification. That said, if you can provide a reasonable basis for your classification, you may be able to seek relief from having to pay employment taxes for that worker. If you can show how your initial classification was correct, and you were consistent with that classification over time, you may obtain relief under Section 530. However, it is important to understand that such relief is scrutinized and not that common. Absent some type of legal advice based upon an uninterpreted regulation, or reliance upon a case that was newly overturned, such relief can be difficult to obtain.
What Businesses Should Do Now
With the many factors to consider when determining whether a worker is an employee or an independent contractor, the classification process can look and feel overwhelming. The goal of these regulations, however, is not to confuse business owners, but to safeguard contractors against exploitation and to ensure that all workers are treated fairly and have their rights respected. With this in mind, make your classification decisions with your worker’s best interests at heart. And play it safe—if there are no clear indicators as to what the status of an employee should be, it is best to err on the side of caution and handle them as an employee.
There are many factors to consider when determining whether a worker should be classified as an employee or an independent contractor. Don’t try to make this decision on your own—seek advice and legal counsel from an experienced business litigation attorney.