Danger Zone: Independent Contractor or Employee?

By U.S. Chamber of Commerce

Today’s employers, pressured by a recovery that still feels like a recession on Main Street, are doing their best to control costs. Since a major part of any business’s cost structure is staff, cutting costs means reducing payroll. At the same time, individuals, bludgeoned by high unemployment, are happy to have any work at all—even contract jobs without benefits.

In this environment, companies will stretch the definition of independent contractor as far as they can to avoid providing benefits or paying taxes—as will workers who are happy not to have taxes taken out from their checks.

One would think when businesses and workers are both willing to have work performed on an independent contractor basis, that would be the end of the discussion. Surely parties can structure a work relationship however they like?

Unfortunately, that’s not the case. No matter what the worker or business wants, it’s the government that decides when someone is or is not an independent contractor.

The perils of misclassification

The penalties for misclassifying employees as independent contractors can be high: back withholding tax, back Medicare and Social Security contributions, back workers compensation and unemployment insurance contributions, back wages, and overtime (as applicable)— all potentially with interest and penalties for late- or nonpayment. Worse, government at all levels is getting more aggressive about looking for misclassifications and levying fines and penalties. [For details, see Web Extra: “How the Government Is Going After Employee Misclassification,” Report Link 77158.]

In addition, while many workers are happy just to be working, some feel taken advantage of and bring lawsuits. I most often see misclassification arise when a worker or contractor is let go, then makes an unemployment claim and an investigation is begun by the Department of Labor. The DOL has no record of the worker because payments into the unemployment system were not made on his or her behalf. The Department of Labor then says, “Well, maybe we’ll look at all of the other contractors you have and see if they’re treated the same way as well.”

If it quacks like a duck…

Calling an employee an independent contractor doesn’t make it so. Agencies

apply the “duck test.” Looks like a duck? Quacks like a duck? Swims like a duck? If so, it’s a duck, not a turkey—no matter what you call it.

An individual probably qualifies as an employee if your company:

• Tells the person where and when to work (i.e., “Be here at 9:00 every day”);

• Requires the work be done on your premises;

• Provides supervision, performance evaluation, and/or training;

• Provides and controls the tools and means to get the job done;

• Requires the work cannot be delegated to another;

• Absorbs/reimburses the expenses related to the job;

• Provides the individual with any benefits, including paid time off;

• Makes any profits (or bears any losses) related to the work;

• Has a continuing relationship with the individual to provide you with services;

• Pays their compensation on pay days, especially if paid through payroll or out of a payroll account;

• Pays extra compensation for overtime;

• Provides the individual with a company title and business cards;

• Lists the individual on the company website and provides a company email address.

There’s no hard-and-fast rule for how much each factor is weighed. Similarly, there’s no black-line rule that says, “As long as you have only three or fewer of these factors, you’re okay.” If this were so, things would be easier for everyone.

Practice safe contracting

Have knowledgeable counsel review your contractor agreements. A properly drafted contract helps make plain (including to the contractor) that this person is not an employee and should not expect any perquisites of employment. Such a contract submitted to unemployment may short-circuit an investigation into a contractor’s claim for benefits.

Have contractors submit invoices that are paid through accounts payable (not payroll). Also, don’t keep independent contractor files with your employee files. Don’t micromanage their work. Allow them to work independently.

Think of a house painter. You can tell the painter you want the house painted green and white, but he or she will tell you when the job will be done and how the paint will be applied. The painter brings painting-company assistants and tools owned by the painting company.

Or, say you hire an independent contractor to develop a website for your business. Of course, you’re going to provide aesthetic and content feedback. But the developer provides his or her own computer hardware and software, comes up with the basic design, and determines how to code the site. Moreover, as long as the developer hits the deadlines or benchmarks you provide, it’s not your concern whether they work 9-to-5, five days a week, for a month straight, or do it all in one caffeine-fueled session lasting 168 hours.

Guidance as to what you need and approval of the end product—these are what you provide to independent contractors. Avoid non-competition agreements, which are better suited for employees. If you’re worried the contractor will take your trade secrets to a competitor, protect yourself with a confidentiality agreement, such as one your company would use with a strategic partner.

It’s always been a good idea to practice safe contracting, but it’s more vital now than ever. I tell my clients they just can’t push the boundaries. It’s like steroid use and sports. It’s always been wrong to juice up, but it was one thing to do it before it was a blip on the radar screen, when no one was looking for it. It’s another thing to do it when Congress is hauling athletes in to testify under oath. What was wrong before is wrong and stupid now.

Joel J. Greenwald, Esq., is the managing partner of Greenwald Doherty, LLP and can be reached at (212) 644-1310 or [email protected]. Read his blog at overtimeadvisor.com.

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