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

The time comes for every successful home-based business owner when one person can no longer do it all. In the early days of your fledgling business you accepted that not only were you CEO, CFO, COO, secretary, treasurer and marketing director, you also had to be laborer, receptionist, janitor, chief cook and bottlewasher. That is simply what you have to do when starting out. In fact, I'll bet you worked harder in your "little home business" than you ever did in your former life as corporate whatever, right? But now the time has come. You have successfully taken your business past the initial, maddeningly slow, frustrating start-up phase to the point where you're seeing some growth ... so much growth in fact that you're finding it near impossible to keep all the balls in the air. The time has come to hire some help. OK, but what kind of help do you need? If it's a secretary/receptionist, that's easy. You go out and hire yourself a competent employee. But what if it's someone to carry out specific projects such as designing a website for a good customer you just can't service within the timeframe the customer needs? What if it's someone to create a marketing program to launch your business to the masses? What if it's a bookkeeper to handle your accounts payable, receivable and everything else in between? The difference between these types of activities and our secretary/receptionist example is that the former are all specific projects whereas the latter is not. When considering whom to hire for your project work, you have a choice ... hire a full-time or part-time employee or hire an independent contractor. By the time you include all the add-on costs of hiring an employee (in addition to wages or salary you need to add on federal and state payroll taxes, social security tax, federal unemployment insurance tax, state unemployment insurance, workers' comp premiums and employee benefits, not to mention shelling out for office space and equipment), hiring an employee becomes a relatively expensive option compared to hiring an independent contractor to do the same work. The add-on costs of hiring an employee usually add about 30-40% to the bill. In other words, if you pay your employee $10 an hour, you'll really be paying $13 - $14 an hour once you include all the add-on expenses. In contrast, although you usually pay an independent contractor more than an employee, that cost will still be less than an employee with the add-on expenses. You may pay an independent contractor $12 an hour without any additional charges. Sound good? Well, read on. It's not as easy as it looks. WHAT IS AN INDEPENDENT CONTRACTOR? So, what is the difference between an employee and an independent contractor anyway? Quite simply, an independent contractor is someone who contracts with someone else to provide specified services for a set price on terms and conditions outlined in the contract. For example, let's say you hire a gardener to mow your lawn and get rid of weeds once a week. Your contract (whether written or not) is that Joe Gardener will arrive at your house on Friday morning, mow your lawn, get rid of weeds and generally tend to your garden. In exchange, you agree to pay Joe $40 for this service each week. Joe supplies his own lawnmower, hedge clippers and weeding tools. Joe decides what time he arrives and how long the job takes (within reasonable parameters). You do not supervise Joe in his tasks or dictate to him how they are to be done. Joe is an independent businessperson and you treat him accordingly. The final product is either to your satisfaction or it isn't. When he's finished, you pay him if you're satisfied with the end result and you don't pay him if you're not. Contrast this with an employer/employee situation. Let's say you own the business Joe's Gardening Service. You employ three employee gardeners to perform services for your business. As the gardeners' employer, you pay them a fixed wage and you withhold taxes, unemployment insurance and various other benefits from their wages to remit to the appropriate government agencies. In addition, you provide your employees with the tools and equipment they need to perform their work. You tell them what to do and supervise them while they're doing it. At the end of the job they get paid by you whether your customer is satisfied with the job or not. In other words, although your customer may not pay you (the independent contractor) because she is dissatisfied with the work performed by your employees, you must still pay your employees because they are not independent contractors - they are your employees and are entitled to be paid a fixed wage. If you are dissatisfied with their work, you can fire them but you can't decide whether to pay or withhold their wages based on the end result of the particular project. ADVANTAGES OF INDEPENDENT CONTRACTORS => Cost As mentioned above, the main advantage of independent contractors versus employees is cost. You can get the same or better service from independent contractors for a lower hourly rate than you can from employees because you don't have to incur all the add-on expenses that go along with hiring employees. => Equipment and Materials In addition, you don't have to provide office space or materials and equipment to independent contractors. As independent contractors (who may also go by the terms "freelancers", "consultants", "self-employed", "business owners" etc.) are self-employed business people, they have their own "tools of the trade". If they're website designers, they have their own office space, computer and printing equipment. If they're gardeners, they have their own lawn mower, whipper-snipper, wheelbarrow and pruning shears. => Legal Liability At law, an employer is vicariously liable for the torts of his or her employees. This means that if you hire an employee gardener who accidentally runs over your customer's pet cat in the driveway of her home when the customer had made it clear that your employees are always to park in the street, in addition to suing your employee for negligence, she can also sue you, the employer, as you are vicariously responsible for the acts of your employees. (And, by the way, this applies whenever your employee is acting within the scope of employment, whether under your express instruction or not. If your employee has a car accident when traveling between jobs and his negligence at least partially caused the accident, you're responsible to the same extent as the employee.) This is generally not the case with an independent contractor unless the independent contractor has been engaged to perform an inherently dangerous activity (such as blasting) or you have attempted to delegate to your independent contractor a non-delegable duty (such as keeping a rental property you own in good repair for the benefit of the tenant). In addition to minimizing legal liability for torts, hiring independent contractors also minimizes your liability for other types of lawsuits such as wrongful termination or job discrimination. DISADVANTAGES OF INDEPENDENT CONTRACTORS There are two main disadvantages to hiring independent contractors versus employees. => Misclassification Far and away the most serious disadvantage is if you misclassify employees as independent contractors. Merely labeling a worker as an independent contractor is not enough. They must actually be an independent contractor. If you do misclassify an employee as an independent contractor, you must pay the IRS all back-taxes owed, plus interest, plus penalty (12% - 35% of the total tax bill). Also, you expose yourself to an increased risk of state audits when your terminated independent contractor files for unemployment benefits. Never mind that you and your independent contractor intended that there be no employer/employee relationship, many's the disgruntled independent contractor who unilaterally decides to recategorize the relationship as one of employer/employee when the spectre of unemployment benefits raises its pretty head. In such situations, you'd better be able to protect yourself by proving that the arrangement was for an independent contractor and not an employee. => Legal Liability Unlike an employee who is limited to workers' compensation benefits, an independent contractor can sue you for negligence if they're injured on the job. That's what liability insurance is for though.