With the Employee Misclassification Prevention Act not passing last year employers shouldn’t feel as they have a free pass when it comes to classifying workers as independent contractors. Employers remain uncertain about taking on the expense of hiring full-time employees and have turned to hiring independent contractors while the economy is. The reasons of for doing this is straightforward: independent contractors cost less than hiring employees because there is no requirement to pay minimum wage or overtime hours in excess of 40 hrs per week; employers do not have to match withheld social security and Medicare taxes; and no payments need be to made for unemployment insurance or workers compensation plans. However, employers might be thinking that they are making a money saving decision but really could end up costing them in the long run because it may lead to potential tax, ERISA and employment law penalties.

Independent Contractor vs. Employee- Does it matter?

Yes it does. Employers have no right to say that workers are independent contractors if they aren’t. The IRS has three elements employers should examine to determine if a worker is an independent contractor or an employee. Here are those elements:

1. Behavioral Control – Who has control of what they worker does? Who sets work hours and determines how or where work is performed? Who provides the tools to perform the duties of the position? Is training provided for 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 elements when deciding whether a worker is an employee or independent contractor. Each case is different and there is no hard and fast criteria for differentiate an employee with an independent contractor. Also, there is not one element that stands alone in making the determination. To really determine if they are an employee or independent contractor would be to look at the entire relationship.

After evaluating these three elements it is still unclear whether a worker is an employee or independent contractor, you can complete and file Form SS-8, which determines of workers status purpose of Federal employment taxes and income tax withholding. Either the employer or individual worker can submit this form to the IRS. The IRS will review the forms and will then issue an official determination of the worker’s status. Be aware that filing could take six months or longer to receive your official determination from the IRS.

As we touched upon earlier, the consequences of misclassifying an employee as an independent contractor can be quite expensive. If it is determined by the IRS 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 improper filed employment tax forms.
• Pay any misclassified injured employee’s worker’ compensation benefits.
• Provide employee benefits including medical insurance and retirement plan contributions, etc.

Bottom Line

The misclassification of workers can have a major effect with a number of costly back pay and legal consequences. Employers should be careful and apply the right classification to workers so that they save money instead of having to pay a bundle in penalties.