Is My New Hire an Employee or Independent Contractor? Potential Problems When Classifying Staff

By
Carl W. Heckert

By Carl W. Heckert

The benefits of hiring independent contractors are many. Besides providing more flexibility when managing fluctuations in your business, independent contractors require no minimum wage, no federal or state tax withholdings, no benefits, no health care insurance, no workers’ compensation and no unemployment contributions requirements. While these cost savings are certainly incentive to label a worker as an “independent contractor,” businesses should beware. Inconsistent treatment of such workers can land you in big trouble with the IRS, federal and state regulators.

Uber, Comcast and FedEx are just a few of the larger companies dealing with enhanced scrutiny and litigation over their use of independent contractors. There have been two successful class action lawsuits in California against Uber for $84 million, and FedEx resolved a case including a $240 million settlement. Misclassification of a person subjects a business to the Fair Labor Standards Act concerning regular wages, overtime and benefits both going forward and in arrears if the employee should have been receiving wages. Minimal penalties may include 100 percent of the employer FICA taxes not paid, plus 40 percent of the FICA taxes not withheld from the employee, 1.5 percent of the wages, $50 for each worker, plus .5 percent of the unpaid taxes per month. However, if the IRS suspects fraud or intentional misconduct, it may increase the financial penalties and add criminal penalties of $1,000 per worker and one year in prison.

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Misclassification often results in workers not receiving benefits that they would have received had they been properly classified as employees and results in decreased payments to unemployment insurance funds and lost tax revenue for the government. Misclassification can also trigger anti-discrimination, health care and retirement obligations. Usually, a misclassified employee would be the person to file against an employer for the loss of benefits or health insurance, often preceded by an injury while working.

So what should you do for your business? Most states, including Delaware, use some form of a general “right to control” test in determining whether a person is an employee or an independent contractor. According to the Courts, the essential indicators of control include the contractor’s obligation to furnish their own equipment, the element of time (who sets the hours the employer or contractor), the method of payment (per job or per hour), who may discharge the worker, who hired the worker and the amount of control of the work that is exercised by the employer. These are not all of the factors considered, and no single factor is absolutely controlling in determining the nature of the relationship.

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My recommendation: If you are hiring an independent contractor, avoid exercising control over them in a number of areas. For example, you should be consistent in your work habits relating solely to the independent contractors, and those work habits should be much different than those you use with employees. For independent contractors, that includes not supervising, not directing services, not controlling work hours, not requiring them to attend staff meetings, not providing them with travel or business expenses directly, as well as following the terms of your independent contractor agreement. Instead of paying them on a weekly or biweekly basis, require them to provide invoices that you pay on the same schedule as your other monthly invoices. When a project is completed, end the contract. Do not have the independent contractor start a new project without a new contract.

Hiring someone as an independent contractor can be the right thing for your business and is certainly not inherently illegal, but the amount of control over the contractor is critical in the determination of their classification being upheld in a legal proceeding. The simplest way to avoid the problem is to use an employee leasing company that is the actual employer. This relationship provides many benefits for using workers only when needed and not being responsible for having to withhold federal or state payroll taxes, provide benefits and carry worker’s compensation coverage for them.

Employers who are unsure of their workers’ classifications are advised to review the assignment of their independent contractors and carefully take into consideration the IRS standards and the state law standards, prior to entering into the relationship. If an employer has specific concerns about worker classification or other employment agreement concerns, it is strongly recommended that they seek the advice of legal counsel.

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Carl W. Heckert is a partner at the law firm Gawthrop Greenwood, PC, where he specializes in Business, Real Estate and Family Law. Carl can be reached at checkert@gawthrop.com or 302-777-5353.

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