Items to Ponder: Misclassification of Workers (IC vs. Employee)

I wish I had a law degree! Both of my grandfathers were lawyers but, sadly, that skill set didn’t pass down to me as an occupation. I considered pursuing law but ended up in a journalism degree, pursuing truth from another avenue.

(And if you ask me, the worst thing that’s ever happened to journalism is the advent of the 24 hour news channels.)

Because I’m not an attorney, I have had to develop a fairly decent skill set at researching things. Lately I’ve been looking at different questions and trying to find answers. I’m going to share a few of the thoughts I’ve been considering and trying to find Truth:

Misclassification of Workers.

I’ve heard this phrase kicked around, but I haven’t been sure it applied to my previous personal situation. So, here are a few links and quotes of things I’ve discovered, as well as questions I’ve needed to ask myself.

What is misclassification of workers? “Employer misclassification of their employees as independent contractors is a widespread phenomenon in the United States. The Internal Revenue Service (IRS) estimates that employers have misclassified millions of workers nationally as independent contractors.[1] While some employers misclassify their workers as independent contractors in error, often employers misclassify their employees intentionally in order to reduce labor costs and avoid paying state and federal taxes… The largest incentive for misclassifying workers is that employers are not required to pay Social Security and unemployment insurance (UI) taxes for independent contractors. These tax savings, as well as savings from income and Medicare taxes results in employers saving between 20 to 40 percent on labor costs.[10]” (Misclassification of Employees as Independent Contractors | Department for Professional Employees)

If you are a small business owner contracting individuals, ask yourself some questions:

How much control do you, a employed small business owner, exercise over an independent contractor in regard to the performance of their duties? (Behavioral Control | IRS)

Behavioral: Does the company control or have the right to control what the worker does and how the worker does his or her job?

Financial: Are the business aspects of the worker’s job controlled by the payer? (these include things like how worker is paid, whether expenses are reimbursed, who provides tools/supplies, etc.)

Type of Relationship: Are there written contracts or employee type benefits (i.e. pension plan, insurance, vacation pay, etc.)? Will the relationship continue and is the work performed a key aspect of the business?

The Department of Labor has an Economic Reality test that might encourage thoughtful consideration on this topic:

According to the DOL, “an employee, as distinguished from a person who is engaged in a business of his or her own, is one who, as a matter of economic reality, follows the usual path of an employee and is dependent on the business which he or she serves.”[7] … The DOL stresses seven factors the Court has considered significant:

1. The extent to which the services rendered are an integral part of the principal’s business.

2. The permanency of the relationship.

3. The amount of the alleged contractor’s investment in facilities and equipment.

4. The nature and degree of control by the principal.

5. The alleged contractor’s opportunities for profit and loss.

6. The amount of initiative, judgment, or foresight in open market competition with others required for the success of the claimed independent contractor.

7. The degree of independent business organization and operation.[8]

These seven factors of the economic reality test aim to assist employers in determining employee or independent contractor status, but in most cases, common sense judgments are sufficient. 

Ask yourself: did the contractor previously possess the skill set needed to perform their duties, or were they required to attend three full days of an orientation as a pre-requisite to their job? Was one orientation and many weeks on the job sufficient for them to have the skill set needed, or must they attend an orientation on an annual basis to be considered prepared?

Have you required independent contractors to attend planning meetings on a quarterly basis? Or perhaps to follow a specific schedule of crisp 30-minute segments during a meeting day? Or follow a prescribed schedule of curriculum regarding what will be presented each day?

Can your business provide a service to the a family if your independent contractor is sick? What if several are sick?

Do your contractors perform the same work for many people?

Companies that misclassify their workers have an advantage over law-abiding competitors because they can lower their labor costs by as much as 40 percent. This uneven playing field means that lawful employers are underbid and lose business, wages and labor standards are depressed across the board, and ultimately lawful employers subsidize the freeloaders in the form of increased workers’ compensation and health insurance premiums.[33]” (Misclassification of Employees as Independent Contractors | Department for Professional Employees)

Why does this even matter? What if all I want to do is provide a program for the small, innocent children who just need a good start in life with a great education?!

“In terms of legislation, states are beginning to pass laws creating a “presumptive employee status.” These laws presume that workers are employees of an employer, not independent contractors, and therefore it is the responsibility of the employers to overcome this presumption by proving that their workers are instead genuinely independent. 27 states have some version of such laws, including California, Florida, Illinois, New Jersey and Wisconsin. Other states, such as Pennsylvania and Minnesota, have laws that only apply to specific sectors.[46] As of 2016, thirty-five states have laws against misclassification of employees, up from thirty states in 2013. [47][48](Misclassification of Employees as Independent Contractors | Department for Professional Employees)

Misclassifying employees as independent contractors and failing to provide W-2 forms can subject an employer to back taxes of as much as 41.5%* of the contractors’ wages, according to the IRS. And these penalties can go back for three years.” If the IRS thinks you intentionally misclassified workers they may seek a criminal conviction with up to a year in jail and a fine as high as $500,000 for a corporation. Plus you get the label “tax evader.” The independent contractor themselves may be audited and may be forced to repay any business deductions they took during that time.

(Do You know the Penalties for Improperly Classifying your Employee as an Independent Contractor? | SHRM Blog)

I think it boils down to being really, really sure – without adding or subtracting anything or playing word games, that you’re doing the right thing in this area and that a common sense test could be passed.

There are grey areas in business, to be sure. I guess my question would be how many of the following questions regarding how to know if you’ve misclassified would apply to the situation?

  1. You Define the Work Hours
  2. You Provide the Equipment or Supplies
  3. The Relationship is Indefinite
  4. You Don’t Receive Invoices
  5. The Worker Only Works for You
  6. There isn’t a Contract
  7. The Worker Performs Core Business Services

(7 Clues Your Independent Contractor is Really and Employee… Under Law | Score)

Do your own research, sit quietly with your answers. If you can move forward with a clear conscience… then do it! And if not… change your path.

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