2015 is fast approaching and if you’re a new business, you might be contemplating whether to hire your first employees or independent contractors. The decision is a critical one, not only because of its impact on payroll and other operational costs, but because of the myriad of legal and financial consequences of hiring workers as independent contractors…and getting it wrong.
First, what are the risks to your business in “getting it wrong”? Consider the following illustration, which is not atypical of many new businesses that go the independent contractor route: You’re a growing business and need to hire help. While your business is increasing, profit margins remain very tight and income is inconsistent, and you don’t think you’re able to afford a typical employee, and associated taxes and benefits. But there is more work than you can handle. You need help. You really need help. So you consider your options and quickly rule out hiring employees, which leaves you with the remaining option: hiring independent contractors. You do some basic legal research online (“Who needs doggone attorneys!?” you yell out to your spouse), and come across the IRS’s independent contractor vs. employee factors. You’re not aware of Washington State’s stricter independent contractor requirements and so completely ignore those. After considering the IRS test, you have a nagging feeling that your worker should be hired as an employee; but finances are really tight, and you conclude that maybe it could work to hire her as an independent contractor. After all, per the IRS test, you don’t plan on directing/controlling the worker to any great degree, and the worker will choose his/her own hours, be responsible for certain expenses, pay their own taxes, etc. They’ll be independent enough, you conclude. Regarding how much to pay the worker, you can’t afford to pay much, so you offer and the worker agrees to $10/hour. So you’re now an employer, hiring an employee-type worker as an independent contractor, paying that worker $10 an hour. It’s not an ideal situation, you think, but what could go wrong?
In a word: plenty. Here are some of the legal tripwires you have just set for yourself–tripwires that can go off at anytime during the course of your business:
- A worker gets hurt on the job and makes a claim to Department of Labor & Industries (L&I) for benefits. Because you’re not registered with L&I as having employees, this triggers an audit/investigation of your business, resulting in an assessment of thousands of dollars in backtaxes, penalties and interest. Moreover, L&I can hold your business responsible for the entire medical cost of the claim (and up to 10 times the cost).
- A worker quits, or you have to fire a worker, and the worker makes a claim to Employment Security Department (ESD) for unemployment benefits. And, again, because you’re not registered with ESD as having employees, this triggers an audit/investigation of your business, resulting in an assessment of thousands of dollars in backtaxes, penalties and interest.
- A worker realizes that at $10/hour, and being responsible for paying her own taxes, she is working for pay that is substantially below minimum wage, and files wage complaint against you to recover wages due. If the worker is paid at some other rate, but hours worked result in the worker being paid less than minimum wage, then the worker could also assert a wage claim against you.
- A worker, who knows she should be classified as an employee (and overwhelming majority do), with entitlement to certain benefits, reports you to the relevant agencies
- A worker sues you in court for unpaid wages, benefits, etc.
- Your company is targeted or randomly selected for an audit by L&I.
- Your company is targeted or randomly selected for an audit by ESD.
- Your company is targeted or randomly selected for an audit by the US Department of Labor (DOL).
- Your company is targeted or randomly selected for an audit by the Internal Revenue Service (IRS).
Each of the above cases is completely out of your control, and if any of the above occur, as the employer who incorrectly chose to classify an employee as an independent contractor, you can be sure you will come out on the losing end.
So, as a new business, what can you do to avoid the above risks? The answer is rather straightforward i.e. be clear-eyed about a whether a worker should be hired as an employee (most often the proper and safe choice) or as an independent contractor…and make the right decision the first time.
As you contemplate hiring in 2015, I have listed below some of the red flags that a worker should not be classified as an independent contractor:
- The worker does not meet many of the IRS independent contractor factors. If she flunks the IRS factors, she will certainly flunk the state’s independent contractor tests.
- The worker is not licensed with the state to conduct the work you are hiring her to perform.
- The worker was not operating her own business before you hired her.
- The worker will not be providing services to you as an independent business i.e. with own company name, business licenses/registrations, office space (home or storefront); marketing materials, letterheads, invoices, separate business expenses; etc.
- The worker is providing services to you for which a business license is not required i.e. the worker is providing services typically performed by employees.
- The worker does not have other clients, and will work only for you.
- The worker will work at your location.
- The worker will provide services under your supervision.
There are many other red flags (and this list is by no means exhaustive), but the above can be quickly determined before making your hiring decision, and if any of them exist, you should be certain to tread most carefully and seek out experienced legal counsel before hiring the worker as an independent contractor. The alternative is make the “easy” decision to hire independent contractors, but then to live under the cloud of things going very wrong, very quickly, when your erroneous IC choice is investigated.
Excellent tips for employee/contractor classification. Many jump and try to handle audits themselves without consulting with an attorney first.
Consulting with a qualified attorney should always be the first step when dealing with audits.
Cheers,
Vic