By Raleigh F. “Sandy” Seay, Jr. Ph.D.
Today, we’re going to look at the question of independent contractors vs. employees. In HR language, this classification is usually called an “independent contractor.” In tax language, it’s sometimes referred to as a “1099 person” and some refer to these persons as “contract employees.” The question is, “Is the person an independent contractor? Or an employee?”
Key Management Principle – Most people in this category do not qualify for independent contractor status. Most are employees. Qualifying for independent contractor status is specific and difficult.
The presumption of the investigating authorities is that the persons are employees and the company has the burden of proving that they qualify as independent contractors. The issue is that some employers have people who work for them, whom they would rather classify as independent contractors, rather than employees, in order to avoid payroll taxes, overtime costs, employee benefits costs, and insurance costs, primarily Workers’ Compensation and Unemployment Compensation. In addition, since independent contractors are not employees, they are not subject to the employment regulations, like EEOC and the Wage and Hour requirements of minimum wages, timekeeping, and overtime.
On the one hand, this question is difficult, because there are two sets of standards, those of the Department of Labor and those of the Internal Revenue Service. Both sets of standards say that no single standard is controlling but that the decision rests with the entirety of the circumstances. However, even though we have two sets of standards, it’s our experience that they both boil down to about the same thing because about 5 standards seem to percolate to the top and, within those 5 standards, one of them is the most important. If you read both sets of standards, they are remarkably similar.
The dangers in classifying someone as an independent contractor, when the person should really be classified as an employee are:
- From the Department of Labor, the person could be due unpaid wages in terms of overtime or other payments.
- From a tax standpoint, the company could be subject to (a) any taxes the person has not paid and (b) the company’s matching Social Security payments.
- From an EEOC, et. al. standpoint, the person may be able to file a claim of discrimination or unfair dismissal.
What are the Qualifications for Independent Contractor Status?
There are a number of qualifications that a person must meet to be considered as an independent contractor, but here are the ones that seem to be most resonant:
- The person must hold themselves out as an independent contractor. Usually, this means business cards, a web site, a clear understanding that this is an independent contractor.
- He or she must work for more than one company. This is the standard that, in our judgment, is most important. If a person works for only one company, he is she is almost surely not an independent contractor.
- For the most part, the person must furnish his or her own working equipment. The company can provide a working space, such as an office, but the person should not have company business cards or send out correspondence on company stationery.
- The person must work largely unsupervised and must set his or her own schedule. In other words, the person must have a substantial “degree of control” over his or her working situation.
- The person must have a substantial opportunity for profit and loss. We would look at whether the person has to make an investment in the project in terms of equipment or capital, whether he or she can make or lose money by meeting certain deadlines, etc.
If we determine that the person largely and significantly meets these standards, we can say that the “employee/employer” relationship does not exist and the person may be classified as an independent contractor. If the decision is “close,” this probably means that the person does not meet the independent contractor standard.
How to Document an Independent Contractor
Since the burden of proof rests with management, we recommend that you have each independent contractor sign a letter stating that he or she understands the independent contractor status and all that this entails. In addition, it’s helpful to have a contract that both parties sign, that includes the conditions of the engagement, such as under what circumstances the engagement can be terminated. This contract should be drafted by an attorney.
Tales from O’Seay’s Fables . . .
Brenden had been working for McMillan Enterprises for several years as an independent contractor. He was quite happy with the arrangement because the company simply wrote him a check each month and didn’t withhold any taxes or anything, and he was responsible for paying taxes on his own. The company was quite happy, also, because they didn’t have to worry about withholding or matching Social Security or benefits or Workers’ Compensation or Unemployment Compensation.
Trouble is, after a while, Brenden quit paying his taxes. Trouble gained speed when the company went through a down period and told Brenden they didn’t need him anymore. Trouble went on a little further when Brenden tried to apply for Unemployment Compensation and was told he was not eligible. That’s when Brenden got mad and decided to challenge the company. “I was not an independent contractor,” Brenden grumbled, “I was an employee! You owe me back wages and benefits and I should receive unemployment, also! Taxes? What taxes? I don’t have any money to pay taxes!” Soon, the taxman cometh. To the company. To collect Brenden’s unpaid taxes.
Having employees misclassified as independent contracts can create significant exposure for a company so as we consider this question, here are four important “takeaways.”
- Workers are presumed to be employees unless management can prove otherwise.
- The burden of proof is on management.
- There are numerous standards but about 5 of them seem to be the most important.
- No single factor is controlling – we must look at the totality of the circumstances.
At Seay Management, we’re Human Resources Management Consultants and offer these observations from a management view. We do not provide tax advice nor legal advice and recommend that you talk with your tax advisor and/or financial advisor, as well as your attorney.
Please let us know if you have any questions about this important issue. We appreciate having you as a friend and client of our firm and look forward to talking soon.