Are you thinking that independent contractors or outsourcing might be the key to your business growth? Watch out, because you might be misusing the independent contractor classification, and that can create some fairly sizable legal and financial risks for your business. Many small businesses that we talk to think about hiring independent contractors when their workload starts to expand because of these assumptions:
- If the revenue level in the business drops, there is no obligation to keep an independent contractor on board.
- The contractor takes care of his or her own tax withholding and payment, etc.
- You only pay for the work the independent contractor does, not for his or her slack time in between projects.
- Your business does not have to get involved with HR regulations and policies regarding schedules, overtime, vacations, etc.
- And more
This might sound great – low risk and little paperwork can sound very appealing. BUT – the IRS has defined what is and is not qualifying as an independent contractor. If you are categorizing as independent someone who actually operates as an employee, your business could face some stiff penalties.
Independent Contractor Defined
In general, if the individual or business sells its services to the general public it could be considered an independent contractor. Think about lawyers, accountants, etc. as representative of this category. An independent contractor is considered self-employed. The IRS says, “The general rule is that an individual is an independent contractor if the payer has the right to control or direct only the result of the work and not what will be done and how it will be done. The earnings of a person who is working as an independent contractor are subject to Self-Employment Tax.”
An independent contractor will use its own tools to get the job done, do the work without your business’s oversight during the process, and will do the work on its own schedule.
The Employer Relationship
An employer not only has the right to control or direct the result – an employer has oversight over what will be done, when it will be done, and often will specify the process for how it will be done. The fact that an employer gives some freedom of action does not mean that there is an independent contractor situation. An employer has a legal “right to control the details of how the services are performed.”
When you are an employer you also have some obligations. You provide tools and work procedures for employees to use. You need HR policies, family leave, hiring and disciplinary processes, and other management-related infrastructure. You are also responsible for payroll tax withholding, and for paying your share of an employee’s Social Security and Medicare taxes. Your business has to collect and maintain accurate I-9 forms for each employee, so that you can validate that the individual is eligible to be employed by you. (This is the place where immigration issues touch businesses.)
Legal Risks of Misclassifying Employees as Independent Contractors
The Commonwealth of Pennsylvania has engaged in a Memorandum of Understanding with the U.S. Department of Labor. This means that the entities share information about violations, conduct joint investigations, and even make referrals to one another regarding potential violations of each entity’s regulations. Simply stated, if your business practices show up on the radar of the Commonwealth as being potentially problematic, count on them also showing up with the Federal government.
If you are found to have willfully violated the law in classifying employees as independent contractors you could be subject to fines, back taxes and fines on employee wages, and even legal action.
Alternative HR can help you make sure you are operating in compliance with the law regarding employment classification. Contact us for an initial consultation or HR audit.