Pay them now

by James Gibson

The House and Senate labor committees are holding hearings regarding the issue of independent contractors, or more correctly, the misclassification of employees as independent contractors.

The "independent contractor solution" is a tempting option in today’s economic climate of growing competition, shrinking margins and the pressure to produce high-quality products at lower prices. This option allows business owners to avoid paying payroll taxes, unemployment insurances, workers compensation and offering benefits of any type. However, think twice, or maybe even three times, before you decide to hire independent contractors.

It just makes sense, doesn’t it? Unfortunately, just because (a) your competition uses independent contractors, (b) you refer to a worker as an independent contractor, (c) you have signed written contracts and agreements with the independent contractor and (d) he/she is paid as an expense item on a 1099 by accounts payable rather than the payroll department, does not mean the individual is in fact, an independent contractor. The working relationship between the individual and the company is the true determinant, and misclassification can result in serious consequences for an organization. These consequences include back-paying taxes (including the individual’s tax liability); retroactively providing benefits, including vacation pay, other paid time-off and 401(k) contributions; stiff financial penalties; workers compensation issues and other potentially expensive legal actions.

The House and Senate labor committees are holding hearings regarding the issue of independent contractors—or more correctly, the misclassification of employees as independent contractors. It's a problem that's generated heightened attention in the Democratic Congress. During hearings, witnesses testified that the incorrect classification of workers as independent contractors cost federal and state governments billions of dollars in tax revenue. The Internal Revenue Service estimates it is losing in excess of $29 billion dollars.

So what is an independent contractor? Regrettably, different government agencies have their own definitions. It is not uncommon for one agency office to enlist the help of other offices, and each will draw their own conclusion. A number of factors could trigger involvement: your "independent contractor" files for unemployment at the end of his or her assignment; your "independent contractor" has a workrelated injury and applies for workers compensation assistance; your "independent contractor" files an EEOC complaint; the IRS randomly selects you or the "independent contractor" for an audit and the list goes on.

So how do you know whether a person is an employee or an independent contractor? The goal is normally to determine who has the right of control. Does the employer have control or the "right of control" over the individual's job functions and how the individual accomplishes the task? The greater the control exercised by the employer over the terms and conditions of employment, the greater the chance the controlling entity will be determined to be the employer. The right to control, as opposed to the act itself, typically is a major factor in determining whether a person holds independent contractor or employee status.

Various federal and state agencies have published their own independent contractor guidelines. Therefore, one agency can determine that an individual, by their definition, is an employee; however, another agency, using the same criteria, can determine the same individual is an independent contactor. Various common law tests are often used by some courts. Consequently, there is no single common and accepted definition for the term "employee" or "independent contractor." Most agencies and courts typically look at the facts and circumstances surrounding the incident, and balance the factors to determine whether a worker is an employee.

The IRS has published a 20-Factor Control Test (far left) that is explicit in its requirements. Although it is not all inclusive, and, as stated earlier, each agency and/or state may have their own definition, it is a starting point.

To make matters worse, even if you have dotted all the I’s and crossed all the T’s, subsequent behavior by your supervisors and staff could deem your work null and void. Including your independent contractor in employee distribution lists, requiring attendance at employee functions, performance and disciplinary involvement by your supervisors and supplying business cards and office space are just a few areas that could be viewed in determining employee classification.

If you decide you still want to choose an independent contractor, have your human resources department and/or legal counsel involved from the start. They should assist in the design of the processes and procedures you will need for your business. All individuals involved must be trained in the treatment of the independent contractor—this is another critical component in the future of your independent contractor program.