Long days, endless nights, blood, sweat, tears and coffee…lots and lots of coffee. This is the familiar sight of a struggling small business owner. But eventually something magical happens; the sun rises over the horizon and you’re rich with customers and clients and have the wiggle-room in your budget to hire additional help. Great! But there’s an important decision you need to make before bringing on that worker: do you hire an employee or an independent contractor?
There are advantages to hiring an independent contractor over an employee.
- Employers do not withhold taxes, medicare, social security, pay unemployment, or workers premiums for independent contractors.
- Employers do not pay vacation, health insurance, paid leave, or provide 401(k) plans for independent contractors
That may seem like an easy choice: independent contractor all the way. But where that really comes back to haunt you is if the IRS decides to audit your business. The IRS can take a look at your hiring practices and determine one of three things:
- You’re doing it right. Your contractors actually are contractors and your employees actually are employees.
- You’ve hired these people as independent contractors, but the work they’re doing is actually the work of an employee and you should be paying for it.
- You’ve hired them as employees, but really you could be hiring them as independent contractors and save on some expenses.
Overtime, Work Duration, and Control
Work Duration and Permanence
This focuses primarily on the duration of the project they’re working on. Is it six months or ten years? There’s no black and white line that says X amount of time is an independent contractor project and Y amount of time is an employee project. That’s when you need to consider the permanence of the worker and their freedom to move on to another job.
Perhaps you’re outsourcing your hiring to a staffing company and they’re providing temp workers for a designated three-month contract. Obviously, these workers are independent contractors (and would receive a 1099 tax form). At the same time you hire a personal assistant without going through the temp agency. At any time the assistant’s services could no longer be needed and you might have to let them go, but when they were hired the work was indefinite. That’s where permanence comes to the forefront.
Let’s consider the above scenario: if you’re hiring someone for a single project that lasts one year and there’s a definite end then they’re likely to be an independent contractor. However, if you hire them to do work at your discretion and that work is indefinite, but you end up having to let them go at the end of a year then they’re actually an employee who happens to have only worked for 1 year.
Control over independent contractor
What is the nature and degree of control the employer has over the independent contractor? After all, an independent contractor is, well… independent. The amount of initiative, judgment, or foresight exercised by the individual is a key criteria. They should be providing a service to you free from your absolute control and direction. If you exert too much control, and they’re really doing things at your direction, then they are most likely going to be an employee and should be compensated as such.
Many employers believe that an independent contractor is not entitled to unpaid overtime. Under the Fair Labor Standards Act (FLSA), which governs unpaid overtime in Texas, workers that qualify as bona fide independent contractors, rather than employees, are exempt from overtime pay.
If an independent contractor discovers that they should have been an employee and their work exceeded the overtime threshold, they can come back with a lawsuit for those missed wages.
The issue of proper classification of workers as employees or independent contractors can have severe financial consequences to the business. Not only is the company subject to retroactive tax withholding, but also penalties and interest if the classification is incorrect. In many cases, the liability springing from an employment tax audit could end the life of the business.
Additionally, officers and owners of the company can have personal liability for these taxes and cannot discharge them in bankruptcy if the business cannot pay. If employment taxes are misappropriated in any way and there is a misclassification, the owner is generally personally liable.
The easiest way to avoid these penalties is to make an honest assessment on whether this person is truly going to be a permanent asset to this organization and if so they are an employee.
In the event of an audit or if your company is selected for audit, you should do the following:
- Select a clear “chain of command” for responding to audit notices and other IRS communications;
- Immediately consult with an attorney who knows independent contractor classification issues, including Section 530 of the Revenue Act of 1978 which provides a “safe harbor” exception in certain circumstances;
- Request additional time to respond to information document requests.
Consult An Experienced Attorney
We always recommend you seek the counsel of an experienced business law or business litigation attorney if you are trying to decide whether or not to dispute a will. A qualified business law attorney can help you make the right choices for your business planning and success. At Romano & Sumner, we pride ourselves on our ability to assist our clients in navigating complex legal processes like forming a business or hiring on help. If you have any questions, please feel free to contact us today.