There can be severe financial consequences for improperly classifying your workers. When some people begin a business, they view calling those providing services independent contractors as a means to save money. Though this is entirely understandable because entrepreneurs live on tight margins, not all people doing work for your company are truly independent contractors.
An employer does not withhold taxes or contribute to Medicare and Social Security for an independent contractor. Those still get paid, but the responsibility is on the contractor and not the employer. The time and money you save by misclassifying someone are not worth the potential consequences.
Factors To Consider
To correctly classify your workers, you must fully understand the relationship between the employer and the employee. The Internal Revenue Service, the U.S. Department of Labor, and state departments of labor all assume that a person working for an employer is a true employee (a “W-2” employee) unless they meet the test for independent contractor. Each of these agencies has slightly different lists of factors that help determine whether a worker is truly an independent contractor, but the key considerations are:
- Behavioral control
- Financial control
- Type of relationship
Imagine that you hire someone to build a house. Regarding behavior, if you have hired an employee, you can direct and control how the work is performed. This includes everything from the hours they work, which tools they use to build the house, and even the training required to make it. With an employee, you determine what the house looks like and how it gets built.
The opportunity for profit and loss is a crucial element of financial control. If you hire an independent contractor to build your house, you get to choose what it looks like and even when it gets built, but you don’t control how it gets done. Furthermore, a contractor may quote you a price to make it. They set their fee to build the house (while maximizing their profit margin). They aren’t earning a regular salary week or wage week after week.
Lastly, how the relationship is perceived is another element to consider. Suppose the worker’s activities are an integral part of the daily business routine, and the worker assumes their relationship will continue indefinitely. In that case, you may be looking at an employer-employee relationship. Things such as healthcare plans, retirement accounts, and other benefits are usually only given to employees as well. For example, if you are a retail store and you hire a graphic designer for a project to design a logo, that person is most likely an independent contractor. However, if you bring on a person to serve customers on the sales floor, that is an integral part of a retail store’s business and that person should be considered an employee.
Perils of Misclassification
If the federal or state department of labor finds that you have misclassified workers as independent contractors when you should have treated them as employees, they can impose fines and order you to pay back wages and benefits. Depending on the size of your business and the length of time that you misclassified workers, the penalty could be significant. For this reason, it is important to the health of your business to properly classify your workers.
Spitz Legal Counsel
If you are a business owner who has employees (or contractors), you need to consider several legal and administrative issues. Attorney Mark Spitz spent more than fifteen years as in-house counsel and has a unique perspective on businesses’ challenges. To schedule a free consultation, contact Spitz Legal Counsel.