Michelle Benjamin Featured in MSNBC’s Business on Main
Why Contract Workers Can Be Bad for Your Business
By Joanna L. Krotz | Business on Main
The feds are cracking down on companies containing costs by hiring contractors to do the work of employees. Here’s how to avoid red flags, IRS audits and stiff penalties.
Despite labor laws and possible penalties, more employers are taking the risk of passing off employees as independent contractors.
Cash-strapped or nervous about the economy, employers are dodging federal and state wages, benefits and taxes that are required for employees but not contracted workers — which can add up to 30 percent more per worker. A hungry workforce and uncertainty about medical insurance costs mandated by the Affordable Care Act (due in 2014) are also driving such tactics.
In response, the government is targeting violators, not only to protect workers but also to recover badly needed tax revenue, reported in the billions by the Government Accountability Office.
This is serious cause to pause. If the IRS or Department of Labor determines you’ve “misclassified” independent contractors, you could be liable for thousands of dollars in back wages, benefits, taxes and penalties — as well as a prison term if intentional fraud has been proven. Even if an investigation finds in your favor, you might still be put out of business by the overwhelming time, costs and paperwork of an audit.
Here’s how to stay on the right side of the law.
What’s an independent contractor?
To start, you can’t hire a worker and call him or her “independent” simply to cut costs. But most employers don’t realize you also can’t get around the law by hiring part-timers or telecommuters.
In February 2013, a federal judge ordered kgb USA, a directory assistance and information provider, to pay $1.3 million in back wages to more than 14,500 current and former employees. These “independent” workers, who all worked from home, responded to customer text messages, with pay being based upon the number of their responses, regardless of hours worked. The ruling said they were due minimum hourly wages.
So what’s an “employee,” and how can you legally tap outside talent?
Workers are determined to be independent based on an IRS test of 20 factors in three categories — yes, 20! Nancy Mobley at Insight Performance, a Dedham, Massachusetts-based human resources consultancy, says, “An independent worker is typically an expert in a certain area and helps the business with a specific project where that expertise is needed.” She cites three major factors for independent classification:
- Freedom of control. An independent contractor decides how work will proceed and be completed. If an employer directs how work is done rather than specifying results, it violates the guidelines. Or, if an employer insists on certain hours, specifies a workplace location or provides job tools, the contractor is often considered an employee.
- Field of competence. Let’s say your company provides IT services and you hire someone to take up the slack during a busy time. That makes him or her a temporary or part-time employee, not an independent contractor. For an IT firm, an independent worker would likely provide noncore services, such as accounting, marketing or HR.
- Client portfolio. However, if a contractor typically provides services like management consulting or software programming to other clients as well, then the case for an independent contractor can be made. Independent contractors typically earn income from several employers, not just one.
Classification hinges on how you control and manage a worker. Even so, the IRS often makes decisions on a case-by-case basis.
On the other hand, the Department of Labor relies on “economic realities” tests. These look into the work relationship, including how much a worker depends on a single employer, and whether the worker’s job should qualify for federal benefits, such as unpaid family leave, retraining, civil rights or disability protections.
Although the IRS and DOL now share information to identify violators (which was not always the case), according to the DOL: “The plethora of tests defining independent contractor status applied across federal and state laws makes it possible for a worker to be classified as an independent contractor under one law, but as an employee under another.”
State guidelines also can vary.
Why worry now?
The DOL has aggressively moved into the enforcement business, and targets are smaller enterprises as often as large corporations.
In 2011, the DOL launched a Misclassification Initiative to push recovery and worker protections. Upon stepping down for President Obama’s second term, Labor Secretary Hilda Solis said in an announcement that in 2012, “we [collected] the most back wages in our history (more than $280 million on behalf of more than 300,000 workers).” In total, almost $5 billion has been recovered.
The DOL’s 2013 budget also added $14 million to combat misclassification and hire more investigators. And the department is forging partnerships with states to share information and coordinate efforts — 14 have signed on, with more likely.
Deciding on a contractor or employee
These tips can help sort out independent versus employee hires:
- Timing. “If I see a definite start and end date, or I am hiring for a specific project, I would hire a contractor. If I am looking for someone to handle a task long term, I would make the new hire an employee,” advises Michelle Benjamin, who runs New York City-based Benjamin Enterprises, a workforce solutions provider.
- Customer interaction. “As a management consulting firm,” says Chris Smith, co-founder of Arryve, based in Seattle, “we shy away from hiring contract workers to handle client-facing deliverables, because our product is largely the consistency we show in what we do and how we do it.”
- Written contract. To avoid blurred lines, ask independent workers to “sign a contract that includes specific guidelines and codes of conduct,” says Randy Stephens, ethics and compliance expert at Navex Global based in Lake Oswego, Oregon.
- Tax filings. Make sure to file an IRS Form 1099-MISC for each independent worker paid $600 or more over that tax year — rather than the W2 for employees. In addition, says Judy Coblentz, chief underwriting officer at Travelers, check that contractors have workers’ compensation insurance. That supports the case for an independent worker.
Lastly, in this climate, if you’re unsure, it’s smarter to ante up for an employee.