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Contractor or Employee: Evaluating the Risk
Posted Tuesday, May 21, 2013 by Pearl Ivey, SPHR
Small employers face more people pressures than ever before. Keeping headcount low due to insurance requirements under the Affordable Care Act, worker’s compensation risks, employment taxes, and increased unemployment ratings when employees don’t meet expectations are just a few of the wide range of costs of employees. Hiring independent contractors often seems like a great alternative. Contractors do not add to the employers head count, do not require insurance, worker’s compensation is avoided along with other payroll taxes, and when the need changes employers don’t have to layoff. The contractor is simply used less or not at all plus there is no unemployment hearing or increase to your tax base. Furthermore, contractors are not provided with 401K, paid time off, do not incur overtime, and often are not treated the same as employees in discrimination suits.
If it sounds too good to be true, it probably is. The extensive pressures of today’s economic market are likely a reason that independent contractor use is on the rise. The cost benefit of hiring independent contractors instead of employees seems huge but so are the risks. President Obama’s commitment since 2010 to enforcement of misclassified employees has been significant and audits have tripled. Maine and other states have also enacted new laws to ensure employee classification is treated seriously. Just a few issues that can trigger an audit include: federal or state tax audit, worker’s compensation claim, unemployment claim, wage and hour lawsuit, federal or state Department of Labor audits, discrimination lawsuit, or merger/acquisition due diligence. A single issue on any of these fronts can trigger a flurry of fines on all sides from a simple misclassification.
One of the most prevalent compliance issues facing small employers in today’s economic market is employee classification. Many employers find that hiring independent contractors or contingency workers can help their workforce remain nimble. They may warrant high rate of pay as compared with a traditional employee; yet the benefits are numerous. Workforce needs are easily met by adding or removing hours from contractors while employee expectations may appear much more rigid. However, civil damage awards and fines for misclassification can be significant. The Federal government has tripled its revenue since 2008 from misclassification audits.
Having a written agreement and paying workers through 1099 basis will not alone protect employers from misclassification. The new rules are very clear on employee vs. contractor relationships. Language in the new law states that:
1. The following criteria must be met:
The individual has the essential right to control the means and progress of the work except as to final results;
The individual is customarily engaged in an independently established trade, occupation, profession or business;
The individual has the opportunity for profit and loss as a result of the services being performed for the other individual or entity;
The individual hires and pays the individual’s assistants, if any, and, to the extent such assistants are employees, supervises the details of the assistants’ work; and
The individual makes the individual’s services available to some client or customer community even if the individual’s right to do so is voluntarily not exercised or is temporarily restricted; and
2. At least three (3) of the following criteria must be met:
The individual has a substantive investment in the facilities, tools, instruments, materials, and knowledge used by the individual to complete the work;
The individual is not required to work exclusively for the other individual or entity;
The individual is responsible for satisfactory completion of the work and may be held contractually responsible for failure to complete the work;
The parties have a contract that defines the relationship and gives contractual rights in the event the contract is terminated by the other individual or entity prior to completion of the work;
Payment to the individual is based on factors directly related to the work performed and not solely on the amount of time expended by the individual;
The work is outside the usual course of the business for which the service is performed; or
The individual has been determined to be an independent contractor by the federal Internal Revenue Service. *(an SS-8 determination)
Contract workers are an important part of many small employers’ strategic plan, providing flexibility, expertise, and extra help when needed. Following the new guidelines will help ensure proper classification of both.
For more information, check out the Maine law at the Department of Labor Website http://www.maine.gov/labor/misclass/employment_standard.shtml
Feel free to contact me about this or other HR topics at firstname.lastname@example.org