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 from 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 of 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 who 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.
Revisit the Issue Regularly