Even though the 111th Congress ended last year without passing the Employee Misclassification Prevention Act, employers should not feel that they have a free pass when it comes to classifying workers as independent contractors.  With the U.S. economy still on shaky ground, many employers remain hesitant to take on the expense of hiring full time employees and have resorted to filling vacancies using independent contractors.  The logic behind this decision seems simple enough: independent contractors cost less than employees because there is no requirement to pay them minimum wage or for overtime hours in excess of 40 per week; employers do not have to match withheld Social Security and Medicare taxes; and no payments need be made for unemployment insurance or workers compensation plans.  However, this “money saving” decision could end up being costly in the long run for employers because it may lead to potential tax, ERISA, and employment law penalties.

Independent Contractor vs. Employee – Does it really matter?

It does.  Workers are not independent contractors just because an employer says they are.  The IRS says that there are three factors employers should evaluate to determine whether a worker is an independent contractor or an employee.  These factors are:

1.  Behavioral Control – Who has control of what the worker does?  Who sets work hours and determines how/where work is performed?  Who provides the tools to perform the duties of the position?  Is training provided to the worker?

2.  Financial – Are the business aspects of the worker’s job controlled by the employer?  For example, does the worker get reimbursed for business expenses?  Does the worker have the opportunity to earn a profit or take a loss for the work being performed?  Can the employer decide not to pay for a piece of work that does not meet expectations?

3. Type of Relationship – Does the worker receive any “employee” type benefits such as leave, pension, or training? How long is the relationship expected to last?  Is the work performed a key aspect of the business?

Businesses should consider each of these factors when making a determination as to whether a worker is an employee or an independent contractor.  Of course, each case is different, and unfortunately, there are no hard and fast criteria that can be used to differentiate an employee from an independent contractor.  And, no one factor stands alone in making a determination.  The key is to look at the entire employment relationship.

If, after evaluating these three factors, it is still unclear whether a worker is an employee or an independent contractor, Form SS-8 (Determination of Worker Status for Purposes of Federal Employment Taxes and Income Tax Withholding) can be completed and filed with the IRS.  This form can be submitted to the IRS by either the employer or an individual worker.  The IRS will review the facts and will issue an official determination of the worker’s status.  Filers of Form SS-8 should note that it can take six months or longer to receive a determination from the IRS.

As mentioned previously, the consequences of misclassifying an employee as an independent contractor can be quite costly.  If it is determined that a misclassification has occurred, the employer may be required to:

  • Reimburse the worker for wages that should have been paid under the FLSA, including both minimum wage and overtime.
  • Pay penalties for not properly withholding federal, state, Social Security, and Medicare taxes.  Penalties may also apply for improperly filed unemployment tax forms.
  • Pay any misclassified injured employee’s workers’ compensation benefits.
  • Provide employee benefits including medical insurance and retirement plan contributions, etc.

Bottom Line

The misclassification of workers as independent contractors rather than employees may have a number of costly back-pay and legal consequences.  Employers should take care to ensure that workers are classified correctly so that their “money saving measure” doesn’t end up costing them a bundle in the long run!

Ann Kontner is a former senior human resources executive with vast experience in all facets of the HR field. She brings to S&J over 25 years of HR experience in corporate compliance, administrative management, staff development and executive leadership skills. She has worked for a wide range of employers including both public and privately held corporations, federal government contractors, and has experience working in both domestic and international markets.
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