Employers often use contingent workers to cut costs. But if they misclassify temps or independent contractors, and those workers are judged employees, then the employer could be liable for back overtime, benefits, federal income taxes, Social Security, unemployment insurance and workers' comp.
So it's imperative that employers know what factors the IRS uses in determining whether an individual is truly an independent contractor, as well as whether independent contractors fall under the protection of federal and state employment laws.
FAQs about independent contractors
1. How can an employer determine whether an individual is an employee or an independent contractor?
To determine whether an individual is an employee or an independent contractor, you must examine the relationship between your company and the worker; more specifically, the amount of independence and control the worker has over how he/she achieves an agreed upon goal. The more control you have, the more likely the individual is an employee of your company. Take a look at the following factors, as spelled out by the IRS:
Instructions the business gives to the worker. Does the business retain the right to control the details of the worker's performance? For example:
- when and where to do the work
- what tools or equipment to use
- what workers to hire or assist with the work
- where to purchase supplies and services
- what work must be performed by a specified individual
- what order or sequence to follow.
Training the business gives to the worker. Employees are trained to perform in a particular manner; independent contractors typically use their own methods.
Expenses. Independent contractors are more likely to incur unreimbursed expenses. Important: fixed ongoing costs that are incurred regardless of whether work is currently being performed.
Worker's investment. Independent contractors often have a significant investment in the facilities used to perform services for someone else.
Other business opportunities. Independent contractors are generally free to make their services available to the relevant market, often advertising and maintaining a visible business location.
Payment. Employees generally are guaranteed a regular wage amount for a certain time period. Independent contractors usually get paid a flat fee per job or by the hour, in certain professions.
Profit or loss. Independent contractors can realize a profit or loss.
Written contracts describing the relationship the business and the worker intend to create.
Benefits provided by the business to the worker, such as insurance, pension plan, vacation pay, and sick pay, show an employee-employer relationship.
Permanency of the relationship. Independent contractors generally work for a specific project or period, whereas employees have more of an expectation of an indefinite relationship.
Whether the worker's services are a key aspect of your company's regular business activity. If they are key, it is more likely that you have the right to direct and control the worker's activities.
Taxes. Independent contractors are responsible for paying their own income tax and self-employment tax. Employers withhold income tax and a portion of employees' Social Security and Medicare taxes.
Don't let one simple mistake open you up to an IRS classification audit. It's costly, burdensome and time-consuming. But by following the vital information you'll find in Using Independent Contractors, you can tell the IRS to "back OFF!” the next time they come knocking.
Get it all here.
2. Is an employer obligated to follow the Fair Labor Standards Act (FLSA) for independent contractors?
Independent contractors are not covered by the FLSA. Just be sure that these workers are truly independent contractors and not actual employees. In determining whether a worker is an employee or an independent contractor, courts and the DOL apply the "economic reality" or "economic dependence" test. The U.S. Supreme Court has ruled that the determination is based on the total activity or situation that controls, and other courts generally use these factors too:
- the extent to which the services rendered are an integral part of the employer's business
- the permanency of the relationship between the employer and the worker
- the amount of the worker's investment in facilities and equipment
- the nature and degree of control asserted over the worker
- the worker's opportunity for profit and loss
- the amount of initiative, judgment, or foresight in open-market competition with others required for the worker's success
- the degree of independent business organization and operation
It's important to note that because the FLSA is intended to remedy oppressive working conditions, courts usually interpret its provisions broadly. And the economic dependence test is no exception. Courts have ruled that a worker doesn't have to be totally dependent on the employer for his/her living, or even have the employer as his/her primary source of income, in order to be considered an employee. Rather, many courts have found that it's usually enough if the worker is dependent on a particular employer for continued employment in that line of business.
While the IRS may come after you demanding burdensome back taxes and penalties if you misclassify an employee ... your contractors can come after you, too.
Complaints to the Labor Department from disenchanted independent contractors are on the rise ... and the Labor Department is only too happy to pursue you, too. If caught, you could be on the hook for millions in benefits you thought only employees were entitled to.
But Using Independent Contractors gives you the tools you need to legally spell out an independent contractor's responsibilities, work schedule and fees ... so there's no misunderstanding which can lead to a nasty lawsuit.
If you can avoid just one mistake in hiring a freelancer, or filling out a 1099 or classifying an employee, then you can save your company thousands, perhaps millions, of dollars. With such potential money and time savings, you can easily pay for the low price of Using Independent Contractors.
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