Entrepreneurs are always looking for an edge when it comes to trimming their costs and maximizing their profits. One of many businesses’ largest expenses is their workforce, however large or small, so they naturally look for ways to minimize those costs. An appealing way to reduce the cost of workers without losing a single person is to treat them as independent contractors instead of employees.
Independent contractors are estimated to cost businesses about 30 percent less than employees – there are no payroll or social security taxes on independent contractors, and there is no unemployment insurance or workers’ compensation cost. The advent of the Affordable Care Act makes the independent contractor classification even more attractive to somewhat more mature companies, as contractors do not count toward the 50 employee minimum needed to be covered under Obamacare.
However, while it might be tempting to classify as many workers as possible as independent contractors rather than employees, business owners must be careful not to run afoul of the law. President Obama has made misclassification of employees as contractors a pet issue of his as far back as when he was a senator, and under his administration, the IRS and the U.S. Department of Labor have teamed up in a joint initiative to crack down on businesses that misclassify workers. Many states have gotten in on the act as well, passing laws and forming commissions that mirror the federal government’s efforts to stop misclassification. Getting caught misclassifying workers can cost you dearly – the government may fine you thousands of dollars per worker for each day you misclassify.
These steep penalties are hopefully enough to scare business owners off from intentionally misclassifying employees as contractors. But how does the honest, law-abiding business owner make sure it doesn’t misclassify its workers by mistake? There is no single determining factor that government agencies or courts look at to determine whether or not your worker is an employee, but if you consider these five factors, you’re well on your way to making the right determination.
How much control does the worker have over how the work is performed?
If you tell a worker exactly how to do his or her job, the worker is more likely to be classified as an employee. If you give the worker leeway to work as he or she pleases as long as the work gets done, he or she is more likely to be considered a contractor. Bosses tell employees when to arrive at work and when to leave, how to accomplish their goals, how much product to make and other specific instructions. Businesses typically don’t take that level of control over contractors. You tell a contractor what you need done and when it needs to be completed, and they have control over the rest. For example, if you hire an independent contractor to paint your house, you would tell him or her what color to paint the house and when it needs to be done and they would take it from there. They would decide how to paint it, what tools to use, what time to arrive to work and so on. In contrast, the head painter might tell his employees what type of brushes and paint to use, what painting techniques to use, what time to arrive and what to wear to work.
How integral is the worker to your business?
The more central a worker is to your business, the more likely he or she will be an employee. Think about it—don’t you want to have control over how a worker does his or her job if he or she is central to your operations? Companies that have purposefully misclassified workers have often overlooked this point, categorizing even executives as contractors to avoid paying benefits. However, if a worker is central to your business operations, that leans toward classifying him or her as an employee.
Does the worker provide his or her own equipment?
If you provide a worker with equipment, he or she is more likely to be seen as an employee. If the worker provides his or her own equipment, he or she is more likely to be considered an independent contractor. In some ways, this ties in with the control question—having the ability to choose your own equipment is certainly a large step toward having the independence to decide how to do the job. Moreover, by having their own equipment, contractors are able to work for other businesses as well and are not tied to you, like employees are.
How independent is the worker’s operations from your business?
A worker who has his or her own business name and his or her own business cards who can be contacted for work independently and not through you has a high degree of independence from you and is more likely an independent contractor. This type of worker can accept work from other businesses beside yours and is not dependent on you for work. In contrast, a worker who has no business name and can only be contacted through you, and who works for no one but your business sounds like an employee.
How permanent is the relationship?
Most independent contractor relationships are for a finite period and often last a brief amount of time. Conversely, employees typically are hired on an indefinite basis and are more likely to be around long term.
While there are other factors to consider, keeping these five questions in mind will generally help you make the right decision as to whether a worker should be treated as an employee or an independent contractor. If you aren’t sure, contact your attorney. You might save yourself thousands of dollars in fines from making the wrong decision.