Independent contractors are a growing part of the workforce in the United States. For a small business employer, utilizing independent contractors versus employees for particular tasks is often preferable, both for productivity and economic reasons.

Businesses often hire contractors for specific projects and time periods and for specified amounts of money. Many employers also use independent contractors for rapidly developing or new areas of interest to their company to allow the company to stay competitive in their field. Hiring a contractor who is already skilled in this new area may save time and money, since you will not need to train that worker before economic results may be realized. Additionally, because independent contractors are considered self-employed, retaining their services can ease the economic burdens that hiring traditional employees often bring, such as providing workers’ compensation insurance, federal and state  income tax withholding, the payment of employment taxes, and providing retirement and health benefits.  

While there are many benefits to hiring an independent contractor for a small business, there are also strict penalties, fees and legal repercussions that can result from your company’s improperly classifying a worker as an independent contractor rather than as an employee.

We asked Nevada attorney Todd Prall, with the professional corporation of Hutchison & Steffen, to give us some practical guidelines on this complicated subject.

Prall advises that the employee-versus-independent contractor issue is important to small business owners for several reasons. First, employees are eligible for health and retirement benefits under a company’s employee benefits plan. Independent contractors  are usually not only ineligible, but mistakenly allowing participation by a non-employee could subject the plan to penalties or even disqualification. Second, the Fair Labor Standards Act affords federal wage and hour protection to employees but not to independent contractors. In Nevada, recent state legislation creates a presumption of an independent contractor relationship if certain elements are met, and relieves the employer from paying minimum wages to that worker. Third, Workers’ Compensation Insurance is usually only available to employees and is an exclusive remedy. If an uninsured independent contractor is injured, the exclusive remedy protection is lost and the contractor may sue the business for any injury incurred.

The fourth reason, and the one that probably affects small businesses the most, believes Prall, is the application of  federal employment tax laws, such as Social Security, Medicare and Federal Unemployment Taxes (FICA and FUTA). An employer is required to pay a portion of these taxes for all employees, and to also withhold the employee’s share of these taxes.  An independent contractor, on the other hand, is considered self-employed, and must pay the full amount of  his/her employment taxes.

The IRS aggressively pursues the reclassification of workers to employee status, warns Prall. Companies who are found by the IRS to have misclassified workers as independent contractors are subject to large government penalties as well as tax liabilities, which include payment of 100% of the combined worker-employer Social Security contribution (FICA), the federal income tax that was not withheld, and unemployment insurance taxes (FUTA).

Prall explains that the IRS utilizes a “common law test” consisting of more than 20 factors to determine whether a worker should be classified as an employee or an independent contractor. The factors fall into three categories: Behavioral, including who controls what, where, and how the worker does his/her job, such as job location, training and hours; Financial, i.e. who pays the worker and such items as tools and supplies, and does the worker have any investment in the business; and Type of Relationship: Are there written contracts or employee benefits that the worker is entitled to, such as pension plans, health insurance, and vacation pay? Does the worker work for more than one company? 

Under Federal law, there are certain categories of workers who are still treated as employees for employment tax purposes, despite their satisfying the common law definition of independent contractor. These “statutory” employees include drivers paid on commission, life insurance sales agents, home goods workers, and traveling salespersons. If your business hires any of these types of workers, you must pay FICA and FUTA taxes on them as “statutory employees.” There are also certain categories of statutory “non-employees.” These workers are treated as self-employed, and  consist of direct-sellers, licensed real estate agents, and companion sitters.

So how do you protect your small business from liability resulting from the employee-versus-independent contractor quagmire? If you want to hire independent contractors to provide services to your company, Prall suggests you have a written contract with the independent contractor specifying his/her employment status, amount and method of payment, and length of employment. The contract should also confirm that the independent contractor is providing for his/her own workers’ compensation insurance,  and is responsible for paying all of his/her own  taxes. Always consult your company’s attorney for advice most appropriate to your small business.

 


The information provided is presented for general informational purposes only and does not constitute tax, legal or business advice.