Reclassifying from Independent Contractor to Employee

One of the key employment questions today is whether a person qualifies as an independent contractor or an employee. This has been a target issue by the Department of Labor for the last several years. Independent contractors do not receive overtime nor keep a time card. They pay their own withholding and Social Security taxes, are not eligible for benefits and do not fall under the employment regulations. In this Time of COVID, some employers have classified their employees as independent contractors instead of employees because, among other reasons, it’s less expensive.

However, it’s our experience that most independent contractors do not qualify for this designation and the IRS and DOL penalties for mis-classification are steep. So, if you survey your work force and determine that, in order to avoid this exposure, you need to reclassify your independent contractors to employees, here are some important points to remember.

  1. Mitigate the exposure. If a person has been improperly classified as an independent contractor, the exposure is already there and can’t be eliminated. The goal would be to mitigate it by making the change promptly and communicating it to those who will be re-classified in a positive and user-friendly way.
  2. Determine the date you want to make the change. Many employers choose January 1st because you would not have to send the person a W4 and 1099 in the same year, which could raise a red flag with the DOL or IRS.
  3. Since the independent contractor is now an employee, decide the compensation you want to pay to the person. The employer will now have to match the Social Security tax and there may be other expenses, such as insurance premiums and unemployment taxes. You may want to reduce the employee’s rate to cover those expenses.
  4. Determine if the former independent contractor is exempt or non-exempt. If non-exempt, you will need to have the employee keep a time record and receive overtime compensation. Most non-exempt employees are paid hourly but there are some exceptions.
  5. Have the employee complete a W4 Form, an I-9 Form and other employment forms that could include a drug policy, etc. Provide the employee with a copy of the employee handbook and have him or her sign a receipt for it.
  6. Communicate fully and regularly with the independent contractor who is now an employee. Explain the change and its implications in a positive way and demonstrate how the former independent contractor will now be better off as an employee. For example, the employee may be eligible for insurance and other benefits like PTO, the employer pays half of the Social Security taxes, the employee is now covered under unemployment insurance and Workers’ Compensation, etc. Frequent communication is essential. Whenever there is a void in communications, most people fill the void with negative thoughts rather than positive ones. So, you must meet with the former independent contractor on several occasions.
  7. The person’s employment date will be the date you make the change. However, you could choose to credit the employee with seniority based on time worked as an independent contractor, for benefits purposes.
  8. Not every independent contractor will be happy with the change so you should be prepared for some pushback. A good way to prepare is to have a list of items to discuss so you’ll be consistent in providing everyone with the same information. If you use a personality temperament analysis like the DISC profile, it’s a good idea to review the person’s pattern, since the employee will receive your communications based on his or her pattern. In particular, prepare for the High C Perfectionistic pattern, which will be very skeptical and will ask lots of questions, like “Why?”
  9. Adding employees through re-classification will increase your total number of employees in the work force and could bring you under some additional employment regulations that come into play based on the number of employees. These include sexual harassment (15 employees), various kinds of discrimination (15-20 employees), pregnancy requirements (15 employees, maybe less), COBRA (20 employees), Family and Medical Leave (50 employees), Affirmative Action Programs and others. Some states and localities have lower employee thresholds. In addition, you may now fall under Obamacare that requires you to offer insurance, so it’s important review these requirements with your insurance representative.
  10. Finally, designate some member of management as a Point of Contact for questions and concerns that may arise. This person should be a natural voice of comfort and assurance, employer friendly and quickly accessible.
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