Many employers have asked whether there is a legal way to classify their new or existing employees as independent contractors or not. There are a number of benefits to paying independent contractors vs hiring employees, such as decreased costs related to employee benefits and overhead related to the required taxes and withholding. Additionally, in some industries, business owners may seek to limit their liability by relying on independent contractors. But it is important to determine whether your workers are in fact independent contractors under the appropriate legal test. Failing to properly classify employees can result in a huge problem for large and small businesses.
Potential Issues with Classification
Some small business owners plan to rely totally on independent contractors when they are first starting out in order to minimize overhead. Unfortunately, for many small business owners, the plan to rely on independent contractors may hit some snags along the way. One common way in which the light gets shone on potential issues with employee vs. independent contractor classification is when a worker who is classified by the payer as an independent contractor files for benefits such as unemployment or workers compensation, which is available only to employees.
In situations like that, the decision to classify a worker as an independent contractor can come under scrutiny from the department of labor in your state. Oftentimes the first sign of an issue with your classification can be in the form of a letter for the labor authority indicating a problem exists. If the worker’s classification is not clearly proper, you can find yourself facing an audit that covers not only the worker in question but also the compensation and work history for anyone you have hired for a period of several years.
If you do end up facing an audit, the labor department is entitled to review all your payroll information in order to compare workers that are employees and those that you have classified as independent contractors. If an employee has been doing work that is substantially similar to someone classified as an independent contractor, or if all your workers are independent contractors, it may result in higher scrutiny. The labor department will likely conduct an investigation to determine whether the workers have worked on site at your facility or place of business and whether or not they have provided work for other clients or customers.
If the labor department determines that any of your past workers who were classified as independent contractors were actually employees, you may be stuck paying huge sums of money for back taxes during the legal look period in your state. The back taxes can even be assessed against you for workers who are no longer working for your business at the time of the audit.
Making the Call
Even if you have taken time on your own to complete due diligence to determine whether a worker is an employee vs independent contractor, you may have reached the wrong outcome. So, if you are planning to rely on the use of independent contractors in your business, it is important that you get the assistance you need to properly classify any potential employees. You can start with a call to the IRS to talk through the facts of your situation and how your business is structured. The IRS customer service agents can provide some guidance, however, when a situation is more complex, it is in your best interests to contact a qualified and experienced employment attorney. An employment attorney can walk through the facts of your specific situation, including completing an analysis on each potential employee type or job description, to determine whether your workers can be safely classified as independent contractors. Additionally, a lawyer can also review previous determinations made by the IRS on whether workers were properly classified to help ensure that any determination your make can be defended should the need arise.
More importantly, an attorney can help you structure your business and your employment classifications in such a way to prevent the need of ever having to defend the classifications you put in place.
Revisit the Issue Regularly
An experienced employment attorney will also stay current on the state of the law as it relates to classification of employees so that if anything changes, you can be alerted and make changes as necessary. It is important to periodically review any positions where you are using workers that you have classified as independent contractors to ensure that the relationship that exists between you and them still constitutes circumstances that allow them to be classified as independent contractors and that changes haven’t occurred to shift them into the category of employee.
Some questions to ask when you first classify someone as an independent contractor or when you review their status include:
Do my independent contractors also do similar work for other clients or customers? Do they identify the same on the tax filings?
Do my independent contractors advertise their services publicly, such as with a website or other print advertising?
Do my independent contractors complete and submit W-9 forms to my business?
Do my independent contractors complete their work and their tasks independently with direction from me and my business limited to end results and big picture items?
At the end of the day, if your answer to any of these questions is uncertain or lead you to believe that the relationship with the worker in question might be properly classified as an employer-employee relationship, it’s time to get an attorney involved to ensure you protect your business from a costly mistake of employee misclassification. If you do not wish to engage legal counsel or seek legal advice, err on the side of classifying an independent contractor as an employee to avoid potentially severe penalties down the road.
The decision to classify a worker as an employee or independent contractor can have serious implications for your business and your bottom line, so it is a decision that is the best made when you have been well advised by an experienced attorney familiar with the facts and circumstances of your specific business.