Misclassifying Employees as Independent Contractors ... One of the Most Expensive Mistakes of Them A

DETERMINING WHETHER JOE IS EMPLOYEE OR INDEPENDENT CONTRACTOR Unfortunately, as far as the various government agencies are concerned, there is not one single test that determines whether Joe is your employee or an independent contractor. Even more difficult, it is quite possible that for the purposes of one government agency Joe is considered to be an independent contractor while for another he is treated as an employee. => The IRS/Common Law "Control" Test The IRS follows the common law "control" test for determining whether someone is an employee or independent contractor. This test looks at 20 factors as being indicative (and only indicative) of whether the person is an employee or independent contractor. The test basically involves a balancing of these factors -- which way does the scale tip? Here are the IRS factors: 1. Whether the worker can earn a profit or suffer a loss from the activity (if so, the more likely it is that the worker is an independent contractor). 2. Whether the worker is told where to work (indicative of employee status). 3. Whether the worker offers his or her services to the general public (indicative of independent contractor status). 4. Whether the worker can be fired by the hiring firm. 5. Whether the worker furnishes the tools and materials needed to do the work (indicative of independent contractor status). 6. Whether the worker is paid by the job or by the hour (independent contractors are more likely to be paid by the job; employees by the hour). 7. Whether the worker works for more than one firm at a time (indicative of independent contractor status). 8. Whether the worker has a continuing relationship with the hiring firm (indicative of employee status). 9. Whether the worker invests in equipment and facilities (indicative of independent contractor status). 10. Whether the worker pays his or her own business and traveling expenses (indicative of independent contractor status). 11. Whether the worker has the right to quit without incurring liability (indicative of employee status). 12. Whether the worker receives instructions from the hiring firm (indicative of employee status). 13. Whether the worker is told how to perform the work (indicative of employee status). 14. Whether the worker receives training from the hiring firm (indicative of employee status). 15. Whether the worker performs the services personally. 16. Whether the worker hires and pays assistants (indicative of independent contractor status). 17. Whether the worker sets his or her own working hours (indicative of independent contractor status). 18. Whether the worker provides regular progress reports to the hiring firm. 19. Whether the worker works full-time for the hiring firm (indicative of employee status). 20. Whether the worker provides services that are an integral part of the hiring firm's day-to-day operations (indicative of employee status). It is important to note that none of the above factors are, of themselves, determinative. The IRS will balance all of the factors to determine which side of the equation is favored. => Other Agencies The other government agencies with which you need to be concerned are: 1. Your state Unemployment Compensation Board. 2. Your state Workers' Compensation Insurance Agency. 3. Your state Tax Department. 4. Your state/federal Department of Labor. Unfortunately each state agency varies in its approach to determining whether a worker is an employee or independent contractor. Many states' agencies use a statutory test focusing on just a few of the "control" test factors. You should therefore find out the factors that your state's agencies take into account before hiring any independent contractors. Most of this information will be available on the agency's website. If not, call them and get them to send you information about their policies. PROTECTING YOURSELF OK, so you know the difference between an independent contractor and an employee, you know the advantages and disadvantages of hiring independent contractors and you know the dangers of misclassification. How do you protect yourself? => Independent Contractor Agreement First and foremost, arm yourself with the IRS' control test factors and the tests used by the various government agencies in your state. Once you have that information, you can structure your arrangements with your independent contractors accordingly. These arrangements should be reduced to writing, in the form of an independent contractor agreement. An independent contractor agreement should contain a description of the services the independent contractor is to perform, by when they are to be performed and the amount the independent contractor is to receive in return for satisfactory service. This agreement can be very helpful evidence in proving that the worker's status was independent contractor rather than employee. Although such an agreement is insufficient by itself (if you nonetheless treat the independent contractor as an employee the agreement will be worthless for this purpose), if the factors weighed by the IRS under the control test are evenly balanced, an independent contractor agreement may well tip the scales in your favor. => Screening Before hiring an independent contractor, put him or her through a few hoops first. It's a good idea to prepare some form of questionnaire to extract the sort of information you would need to be able to prove in support of your argument that the worker is, in fact, an independent contractor and not an employee. Examples of such information (courtesy of the NOLO website - http://www.nolo.com) include: 1. Whether the worker has formed a legal entity for his or her business. 2. Whether the worker has filed a fictitious business name (also known as a "DBA" or "doing business as"). 3. The worker's business address and telephone numbers. 4. The number of employees employed by the business. 5. Whether the worker has any professional or business licenses. 6. References from other business for whom the worker has performed services as an independent contractor. 7. How the worker markets his or her business. 8. Whether the worker maintains an office separate from his or her home. 9. A description of the equipment and facilities the worker owns and will use in the project. 10. Whether the worker has business cards and stationery etc.. 11. A listing of the types of insurance coverage the worker has for his or her business. Request documents that evidence the responses to the above questions. For example, get copies of fictitious business name statements, professional and business licenses; references; business cards and stationery and insurance policies. At the end of the day, whether you hire an employee or an independent contractor is a decision for you and your business. If you feel you can adequately protect yourself against an allegation of misclassification then, by all means, follow the independent contractor route if that makes most sense to you. But if you don't feel confident in managing the relationship to protect yourself from such a charge, for your own peace of mind, you may be well advised to hire an employee even if that is more expensive up-front. After all, if you get it wrong, you'll be paying those additional costs anyway in the form of back-taxes (and interest and penalties to boot).