Employee or Independent Contractor? The Dangers of Misclassification.
Employers looking to save as much money as possible sometimes try to get around legal and financial obligations to workers who should be classified as employees by classifying them as independent contractors, but even an honest mistake can have serious consequences for business owners. Employment status affects employment benefits, tax implications, liability, and other issues. Any employer looking to work with independent contractors should know some of the key differences between the two classifications before deciding which type of worker to hire.
Let’s talk about a few of those differences…
How long will the independent contractor be working for you?
If the staffing need relates to a specific project with no likelihood of continued employment after project’s completion, using an independent contractor would avoid the problem of having to lay off an employee when the project is done.
Do they only work for you?
If the company needs the worker’s full-time efforts over an extended or indefinite period, the situation would likely call for a traditional employee. Long-term independent contractors who have only one client are viewed as suspicious as they are similar to employees. If the organization needs the worker only part time, does not object to the individual having other clients or will be satisfied as long as the worker meets set deadlines, then the organization can feel confident in engaging an independent contractor.
Control
If the employer rigidly prescribes the manner in which the work is performed, that weighs toward employee status. Hiring an employee would be the safer course of action. If the organization is concerned only about the final product and does not need to dictate how the worker gets from point A to point Z, an independent contractor may be the preferred approach.
Are you providing an office, supplies, or equipment?
True independent contractors do not need organizations to provide them with an office, equipment or other basic necessities of doing business.
Are any of your other employees doing the same job?
Employees and independent contractors doing the same job is a big red flag. If challenged, the employer will be expected to offer a clear and convincing rationale that does not involve avoiding legal obligations.
What Are the Legal Ramifications of Misclassification?
Independent contractor arrangements have drawn increasing scrutiny and significance with the large number of workplace laws covering employees and the growth of the contingent workforce. Misclassification of an individual as an independent contractor can give rise to a variety of liabilities such as
Tax consequences
Employers are required to withhold income taxes on the basis of information employees provide on IRS Form W-4. If an employer fails to withhold income taxes on behalf of a worker improperly classified as an independent contractor, and the individual has failed to pay the taxes, the employer may be liable for federal or state taxes that were required to be withheld but were not.
Workers’ compensation
A misclassified worker can result in the supposed employer being held liable for on-the-job injuries outside the protections of the workers’ compensation system, and for penalties as well.
Unemployment compensation
A worker may file a claim for unemployment compensation and be granted benefits if the unemployment agency believes that the worker was misclassified as an independent contractor. If the organization misclassified the worker, it may be liable for penalties and interest in addition to unpaid unemployment insurance premiums.
Wage and hour liability
The widespread use of independent contractors invites the scrutiny of attorneys who may be eager to bring a class or collective action suit for unpaid overtime or minimum wage violations under the FLSA or state wage and hour laws.
Questions to Ask
- Are the independent contractors paid the same way as your employees and at the same time? Payment in the same manner (for example, if the checks look identical and are paid out on the same day as your regular employees) …is not good practice!
- Do the independent contractors go through progressive discipline if there are performance problems, or are their contracts terminated? Progressive discipline shouldn’t be used for independent contractors.
- Do the independent contractors have company credit cards or expense accounts? If they do, they are employees, not independent contractors.
- Are the independent contractors reporting to company supervisors? This is another potential trouble spot, as reporting to supervisors would undermine contractors’ control over their own work. The more control a company exercises over individuals’ work, the less likely they are independent contractors.
So How do you Classify Properly?
No legal test applies in every situation when deciding to classify a worker as an independent contractor. For example, the IRS and DOL use different, although similar, frameworks.
To minimize legal risk, employers are advised to use federal government, state government, and agency tests as guidelines to create a questionnaire or checklist when determining worker classification.