Independent Contractor

The financial benefits of hiring independent contractors (ICs) can be substantial, but so are the risks of misclassifying them. There are numerous areas of costs savings that an employer can enjoy by hiring ICs instead of hiring employees. These include:

  • No employment taxes
  • No health insurance benefits or ACA compliance
  • No state or federal minimum wage or overtime laws
  • No meal or rest periods
  • Not covered by unemployment insurance
  • Not included in OSHA regulations
  • No need for Workers Compensation

Each of these areas can result in significant financial savings for the employer, IF the worker is correctly classified as independent.

Federal Agencies that Oversee ICs

There are six different agencies that assess the status of an individual as independent contractor or employee. Depending upon what they are evaluating, the areas of consideration can vary dramatically. A worker may be defined as an IC by one agency, but not by another. The six agencies are:

  1. Internal Revenue Service (IRS)
  2. Immigration and Naturalization Service (INS)
  3. Employment Development Department (EDD)
  4. Department of Labor (DOL)
  5. State-specific Labor Commission
  6. Workers’ Compensation

There is no set definition that applies for all purposes. It is recommended to visit the IRS, DFEH or state agency websites to find the relevant information.

What Defines an IC?

There are six primary factors that determine that status of a worker as an IC. These factors are:

  1. Right to control manner and means by which the individual performs the job
  2. May work for several employers
  3. Typically sets own hours
  4. Usually has own tools
  5. Typically paid per job
  6. Cannot be fired “at-will”

As noted previously, not all factors are required by all the groups.  While “the right to control” is accepted by all six agencies, only five consider “paid by the job”, “have your own tools” and “can’t be fired at-will” as factors (the DOL does not consider those factors), and only the IRS and EDD consider “sets own hours” as criteria.

How to Determine the Status of Your Own Staff

There are questions that management can ask to assess the validity of an independent contractor classification. While there is no single formula, below are some common red flags that should be considered:

  • Has the individual’s contract been extended or renewed either formally or informally over time?
  • Do you provide the equipment needed to do the job such as a desk, computer, office supplies, or other tools?
  • Do you train the individual on how the job needs to be done?
  • Do you decide the individual’s hours or are they required to submit reports on time and activities?
  • Was the individual once an employee, but now substantially performs the same job, under similar working conditions, but as an IC?

If you answered “Yes” to any of these questions, the individual is most likely an employee, not an IC.

Here is a typical example of a misclassified employee: an employee at a gym was declared to be an independent contractor. However, management requires they follow a set schedule and take specific instructions on how to do their job, including cleaning and maintenance of equipment. They do not have the freedom to make their own hours or use independent judgement in performing the work at hand. Clearly, this individual is not an IC and should be reclassified as an employee.

Not an Independent Contractor

From time to time, individual employees may request to be considered an IC. While they may want that classification, it is not their call. Below are examples of situations that do NOT create an IC relationship:

  • Employee wanted to be treated as such
  • Signed a written contract
  • Does assignments sporadically, inconsistently or on call
  • Is paid commission only
  • Has no supervision

Additionally, an employment contract that violates the law is not binding and the employer will not be protected should the employee choose to sue for misclassification. Organizations are not immune if the individual is paid commission only, has no supervision or does work on-call.

Consequences of Misclassification

The civil penalty for violation of the law ranges from $5,000 to $25,000 for each violation.  Employers are also liable for all unpaid employment taxes and related penalties, and all unpaid wages and overtime (if applicable).

Beyond the financial penalties, there are additional remedies as well. Firstly, the employer is required to display on its website or in the workplace a notice of the serious violation of misclassifying an independent contractor. The notice must be posted for one year, and signed by an officer of the business.  Additionally, a statement that the employer has changed its business practices in order to comply with the law and information on how to contact the Labor and Workforce Development Agency to report misclassification must also be displayed.

While classifying workers as independent contractors may seem attractive at the front-end to save on taxes, insurance and wages, odds are the money saved won’t begin to cover the costs and embarrassment of misclassifying them.