Updated: Dec 29, 2020
Let’s face it, hiring an independent contractor rather than an employee seems to have all the benefits in the world: the business owner doesn’t have to worry about payroll taxes, insurance benefits, Social Security and Medicare taxes, or unemployment and workers compensation insurance. Additionally, perks such as vacation and holiday pay are allotted to the employee, whereas they are not for an independent contractor.
At first glance, this can give the impression that hiring a worker as an independent contractor is the most beneficial, especially when a business is in its beginning stages.
What can happen if you get caught misclassifying a worker as an independent contractor when they should have been labeled an employee?
Many small business owners will hire an independent contractor but then manage the worker in the same way they would an employee. As the two are not interchangeable, each come with their own pros and cons.
One reason it is so important to understand this distinction is that the IRS is on the lookout for business owners who misclassify. One red-flag they are looking for is when they see a worker file a 1099 of more than $10,000 from a particular business. Another way is by catching-wind from a disgruntled employee or a routine audit of the business.
Look, we all know the government wants their taxes and when they find someone skimping, they come down hard. Most business owners (especially small businesses) are not equipped to handle these penalties.
Imagine a business started a year ago and, in an effort to save money, has been misclassifying many of its workers. If the IRS finds out, how likely is it that this new business owner will have the financial reserves to fork-over back payroll taxes as well as back unemployment and workers compensation insurance premiums?
If that’s not bad enough, the business owner could also be liable for unpaid overtime costs, penalties, and attorney’s fees. Yikes! Many will crumble in this situation.
What exactly is an independent contractor?
Now that I have your attention, let’s take an honest look at what an independent contractor is in order to see when one should be hired.
Below are a few bullet-points on the general characteristics of an independent contractor:
The independent contractor’s work methods are not controlled by the employer.
The independent contractor is responsible for their own training and certifications.
The independent contractor typically sets their own hours.
The independent contractor advertises and promotes to obtain clients.
The independent contractor typically supplies their own equipment and workspace.
The independent contractor determines how the work is performed and the sequence of actions he is going to take to get the job done without direct supervision.
The independent contractor is free to work for others as well as hire their own workers to assist in completing projects and jobs.
Another key distinction is that the work of the independent contractor is generally not related to the company’s core-work.
For example, a business owner runs a company that builds websites. The core-work here is “building websites”. If this business owner hires someone to do his bookkeeping in an effort to keep financial records straight, this could easily be considered an independent contractor role as bookkeeping services are not directly connected with the business’ “core-work”. Conversely, if this same business owner hired website developers as independent contractors, the business owner may be hard-pressed to convince the IRS that they should be classified as such.
Look at it this way: when hiring an independent contractor, a business is basically hiring another individual or company to get a specific product or service done for them. If the business owner’s roof needed to be replaced, he would call a roofing contractor to handle the specific job of replacing the roof. What he wouldn’t do is tell the roofer what hours they needed to work or how the roofer should go about removing the existing shingles or how to replace them. Additionally, the business owner wouldn’t supply tools for the roofer and he wouldn’t restrict him from hiring outside help to get the roof replaced.
When is a worker an employee?
We’ve isolated what makes-up an independent contractor, now let’s delve into what constitutes an employee.
The more “yes” answers the more likely the worker is performing as an employee, not an independent contractor. In fact, even a single “no” warrants discussing the situation with legal counsel.
Does the employer train the worker?
Does the employer determine the work schedule?
Does the employer provide the tools or equipment associated with the work?
Does the employer instruct the worker on the sequence of services to be performed?
Does the employer have the right to fire the worker without cause or advance notice?
Does the employer provide an office or workspace for the worker?
Is the worker prohibited from hiring, paying, and supervising assistants in order to get the job done?
Does the employer require oral or written reports from the worker?
Does the employer pay by the hour, week, or month rather than for a specific project, product or service?
Does the employer pay for the worker’s business and/or travel expenses?
Does the employer require that the worker personally provide the service? In other words, is the specific worker expected to provide the service, rather than the worker being able to out-source the tasks?
Does the worker provide services to one employer and not two or more persons or businesses at the same time?
Does the worker devote full-time service to the employer?
Does the worker have the right to terminate the relationship (quit the job) at any time without incurring liability (the need to pay damages or provide something to the employer as a consequence of terminating the relationship)?
Is the worker integrated into the employer’s business? Put another way, are the services being provided by the worker essential for the success or continuation of the employer’s business?
At this point, you should have enough information to determine when a business should hire independent contractors and when they should hire employees.
As tempting as it may be to hire an independent contractor, the risks often far outweigh the benefits.
If it is discovered that a business owner was misclassifying employees as independent contractors, the business owner may be able to avoid some or all of the penalties if they are able to show a substantial reason for that classification. However, this is not an easy road. Seeking legal representation is something I would highly encourage as this situation could be quite complex and your business and livelihood are at stake.
Contact atCAUSE Law Office for a Consultation
Call atCAUSE Law today at 727-477-2255 or contact our business law office to schedule an appointment and meet with an attorney who can help you to determine if your business should hire independent contractors or employees.
Ashly Guernaccini is the founding attorney of atCAUSE Law Office. With over a decade of experience in business law, Ashly is certain that good lawyering does not involve a one-size-fits-all approach. She’s an advocate for businesses of every size, whether it’s a small local business or a large corporation.