When making staffing and hiring decisions, one question companies commonly face is whether to engage independent contractors or employees. While using independent contractors has its benefits (such as not having to pay payroll taxes for those individuals), it can carry legal risks if a person is misclassified as an independent contractor as opposed to an employee. For example, for tax purposes, if the IRS determines that a business has misclassified a worker as an independent contractor, the business could be held responsible for additional taxes for that misclassified worker. Under fair labor laws, a business that misclassifies workers could be subject to civil penalties. Also, the business could be liable for paying a misclassified worker back-pay, such as overtime, under state law. To avoid such risks, it is therefore important to make the correct determination from the start. In doing so, the following factors should be considered:
Level of Control
Does the business have a considerable right to control how the worker does the work? For example, does the business control where and when the work is done? Does the business mandate what tools or equipment must be used? Must the worker follow a specific process or sequence to get the job done? The more the business dictates the process of getting the work done rather than just seeking an end product, the more likely the worker will be classified as an employee.
The business also needs to consider the level of financial control it has over the worker. An independent contractor will more likely have un-reimbursed expenses as a cost of his or her own business, whereas an employee will be reimbursed for business-related expenses. Independent contractors usually supply their own equipment and facilities. Another factor to consider is whether the worker is allowed to perform the same kind of work for other companies. If not, then the scale may tip more towards the worker being an employee. Also, the method of payment to the worker is a consideration. If the worker is paid hourly as opposed to a flat fee, such arrangement is indicative of an employer-employee relationship.
Contractual Relationship
Even if the business and the worker have a contractual agreement that says the worker is an independent contractor, it may not be enough to establish the worker as an independent contractor. The actual working relationship between the parities is more important that the title given to the person performing the work. Playing into such relationship are considerations including the term of the contract and the services provided by the worker. If the contract is for a specific period of time, such as a year, that tilts more in favor of an independent contractor rather than an employee-employer relationship. If the services provided by the worker are central to the business of the employer, the scale may tip again to the employee-employer relationship determination. Another factor to take into consideration is whether the worker is hired as an individual or if the company is hiring the worker’s company. To the extent the worker provides services through a separate legal entity owned by the worker, then such arrangement is more typical of an independent contractor relationship.
As is plain from the discussion above, there are many factors to consider in such cases, and each case has its own unique facts and circumstances. Before making a decision to treat a worker as an independent contractor or an employee, it is advised to seek legal counsel. If you would like more information regarding the use of independent contractors, please contact our Business Law Group partner, David A. Closson at [email protected].