Classifying employees correctly is a serious matter that needs to be done with care. And while you might think this goes without saying, the truth is many employers routinely mis-classify workers. In 2008 (more recent numbers not yet available), the Department of Labor received 23,845 complaints of wage and hour abuse and collected more than $185 million in back wages.
When improperly classified as independent contractors, workers miss out on all the benefits and privileges of employment, and employers fail to pay required payroll taxes, something the government takes an extremely dim view of.
So is it independent contractor or employee? How do you get it right?
Independent contractor versus employee: What’s the difference?
Determining the difference between an employee and an independent contractor can be a bit challenging but is by no means impossible.
The Internal Revenue Service (IRS) considers three common law rules when making a decision:
- Behavioral control– Who has the right to direct or control how the worker does the work? What is the type and degree of instruction? Who provides training? How is the work (and the worker) evaluated?
- Financial control– Does the work provide the opportunity for profit or loss? How is the worker paid? Does the worker provide services to other establishments? Has the worker invested in his business?
- Type of relationship– Is there a contract clearly outlining the nature of the relationship? (Note: A contract in and of itself is not proof of an independent contractor/employer relationship.) How permanent is the relationship? Is the employer providing benefits? Is the work the worker does considered “key” to the business? (If a worker provides services that are a key aspect of the business, it’s more likely the business will have the right to direct and control the worker’s activities.)
The employer will have to weigh all these factors when deciding whether a worker meets the criteria for an independent contractor or functions more like an employee.
Tips for keeping your contractor/employee relationship within the law.
Again, whether a worker is truly functioning as an independent contractor or more like an employee won’t be determined on the weight of any single factor. Instead, the totality of factors will define the nature of the relationship. As an employer, your goal is to “stack the deck” in favor of a contractor/employer relationship by abdicating as much behavioral and financial control to the contractor as is possible. For example:
Be hands off. The contractor is the expert, not you. Most likely, you’re hiring a contractor to do a specific job for a specific length of time because no one in your organization has the expertise. As such, your only concern should be that the work is done to standard and to deadline. How the work is done should be left to the contractor/expert.
Be flexible. The contractor should be free to set his own work hours and fee schedule. You’ll need to agree, of course, but the point is that you can’t dictate conditions of work with a contractor as you would with an employee.
Be reasonable. You’re well within your rights to protect your company’s proprietary information, but expecting a contractor to sign a convoluted agreement with all kinds of restrictions (especially restrictions about who else the contractor can work with) without any consideration for why the contractor should do so is negotiation in bad faith and could cause you a problem later. The contractor needs to make a living by working with many clients. Don’t try and box him in so that he’s mostly dependent on you for his livelihood. Employees are dependent. Contractors should be independent.
Be upfront. Speaking of agreements, be sure and have one that clearly outlines the nature of the relationship as well as the consequences should either party violate the terms.
Mind the lines. If it walks like a duck and quacks like a duck, it’s probably a duck. If your contractor has become so ingrained in your company that she “looks like” every other employee, you need to make some changes.
Avoid things like:
- Assigning the contractor a company email address
- Inviting the contractor to company “social” functions, like holiday parties
- Reimbursing the contractor for work expenses that aren’t part of the written agreement and aren’t customary for the field (i.e., reimbursements more similar to what you’d afford your employees)
- Providing the contractor with equipment and supplies
- Assigning someone within your organization to manage and evaluate the contractor using the same tools and methods that individual would use to manage and evaluate employees
- Paying the contractor in anything other than a “fee for service” model
The White House has made it very clear that wage and hours issues are a top priority. Since President Obama took office, the administration has been cracking down on employee misclassification in all its forms, illegal unpaid internships, unequal pay for women, and low minimum wages.
Don’t get caught in the cross hairs by failing to properly classify and manage your independent contractors!