(December 2023)
Business owners or managers are constantly challenged by having to control operating expenses and still provide quality products and timely service. At first glance, it seems like using independent contractors for some operations reduces expenses. However, this approach should be examined carefully because the disadvantages and possible penalties may more than offset any perceived savings. Qualified legal counsel should review using independent contractors, and the decision to do so should be made with full knowledge of the potential legal, financial, and practical consequences.
Below are five different court cases where the status of the injured worker was in dispute.
Anesthetist Was Hospital’s Employee, Not an Independent Contractor
Claimant Injured In Scaffold Collapse Was Employee, Not Independent Contractor
Contractor Was an Employee Rather Than an Employer
Newspaper Delivery Persons Were Employees, Not Independent Contractors
Truck Driver Was an Independent Contractor for Purposes of Workers Compensation, Not an Employee
Using independent contractors may result in premium savings in two areas.
The employer is required to withhold federal, state, and local income tax on all of its employees. It is not required to do so for its subcontractors. This is another area of potentially significant savings.
Social Security (FICA)
The employer is not required to withhold and pay Social Security and Medicare taxes for its subcontractors.
Unemployment Taxes and
State Disability Income (SDI)
This is another area with potentially large savings because the named insured does not pay any of these taxes for its subcontractors.
Company-Provided Benefits
Many businesses provide a number of important benefits to their employees, including all or part of the costs of the following:
Independent contractors are not eligible for and do not receive such benefits. As a result, this is yet another area of potentially significant savings.
Tools, Equipment, and
Supplies
Independent contractors usually provide and maintain their own tools, supplies, and equipment (including vehicles). Depending on the details of particular operations, using independent contractors to perform certain work could be a very important way to reduce expenses.
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Example: General Novelties, Inc. sells its products through independent salespersons. It pays on a commission basis instead of using employees. Each sales representative owns, uses, and maintains his or her own vehicle. This saves General Novelties the expense of purchasing or leasing and maintaining a fleet of motor vehicles for its own sales representatives. |
Insurance Premiums on
Audit
Business owners must pay additional premiums when a misclassified independent contractor is determined to actually be an employee. The amount of premium involved with workers compensation and commercial general liability coverages in such cases can be significant. In addition, the insurance company has the right to go back several years, perform revised audits, and charge additional premiums for previous policy periods.
Social Security (FICA)
Withholding
If it is determined that a worker is an employee and not an independent contractor, Social Security tax that was not withheld is due and payable immediately. This includes additional percentage penalties and possible fines that could be significant.
Unemployment Taxes and
State Disability Income (SDI)
Similar to FICA withholding, unemployment and state disability income taxes based on employee compensation is due and payable immediately after it is determined that an employee was misclassified as an independent contractor. Fines and penalties for such misclassifications can be significant.
Loss of Workers
Compensation Protection
Business owners and their employees are eligible for workers compensation coverage. Workers compensation coverage and benefits may not be available to them if the named insured uses independent contractors to perform all business operations. If an independent contractor is deemed an employee after an accident, and the employer does not carry workers compensation coverage, the employer is personally responsible for the payment. It must also pay a substantial fine because it did not carry workers compensation insurance.
Quality and Continuity
Employees have a vested interest in the quality of the employer’s product(s) and the timeliness of providing their employer's service(s). There is also a continuity of operations as one employee trains newly hired employees. The company's culture can be passed on through the employed staff. Independent contractors are interested in maximizing their short term profits from the specific contract, not in whether or not the business continues to operate.
Cost
Independent contractors are paid based on projects completed. Their cost structure must include many of the same factors any employer must consider. The initial cost may appear lower, but cost overruns, poor quality, do-overs, and other factors may result in higher ultimate costs.
This publication provides guidance on what the IRS calls common-law rules. They state that the evidence as to whether a worker is an employee or independent contractor can be found by examining three categories of control:
This publication provides items to consider, along with examples of how these relationships might work in different types of industry.
This publication was first published in 1987 as a guide to determine a worker’s status. It lists 20 criteria to evaluate and determine who is an independent contractor versus who is an employee. The recurring theme throughout the list is “control” of the work performed. This ruling also explains that the way the relationship or the compensation is labeled, described, or designated is irrelevant to determine a worker’s actual status.
The entity that controls the worker's activities is the ultimate determining factor. The worker that has more control over the work is more likely to be an independent contractor. On the other hand, if the employer has more control over the work, it is more likely that the worker is an employee. It is extremely important to remember that no single factor is used to make this determination. The entire test should be applied to the situation, and the individual responses should be summarized to arrive at the final determination.
A recap of this ruling with the 20 criteria follows.
1. Instructions
A worker who must comply with the compensating entity's instructions with respect to when, where, and how to perform work is probably an employee. A worker who establishes when, where, and how to perform the work is probably an independent contractor.
2. Training
A worker who must be trained or who is required to have training to perform the compensating entity's work is probably an employee. Clients do not usually train (and are not usually required to train) independent contractors.
3. Integration
Workers whose services are integrated into and become part of the employer’s business operation are probably under the compensating entity's direction, and control and are probably employees. Independent contractors do not usually integrate their services into the workflow this way.
4. Services Rendered
Personally
The entity for whom a worker personally performs services is usually interested in the methods used and the results attained. This suggests exercising control, and that worker is probably an employee. Workers who are not required to personally perform the needed services are probably independent contractors.
5. Hiring, Supervising,
and Paying Assistants
The entity that controls hiring, supervising, and paying assistants or helpers usually determines who controls the relationship. If the entity that compensates a worker performs these functions with respect to that worker's helpers or assistants, it is probably an employer and employee relationship. On the other hand, workers who hire, supervise, and pay their assistants are probably independent contractors.
6. Continuing
Relationship
Even irregular relationships that recur suggest that it is an employer and employee relationship. Such relationships do not usually occur with independent contractors.
7. Set Hours of Work
A worker is probably an employee if the compensating entity establishes and controls the hours of work. Independent contractors usually control and set their own hours.
8. Full-Time Required
If the compensating entity controls the amount of time a worker spends on the job (which serves to restrict that worker from other contracts or employment), that worker is probably an employee. The opposite applies to independent contractors who usually control their own hours and when and where they work.
9. Doing Work on
Employer's Premises
A worker is probably an employee if the compensating entity exercises control over the location of the work, routes traveled, or the territory canvassed. Independent contractors usually work from their own locations and control their own routes and territories, but not always.
10. Order or Sequence
Set
A worker is probably an employee if the compensating entity controls, sets, or has the right to establish the schedules and routines to be followed. Independent contractors establish their own schedules, routines, and patterns of operation and work.
11. Oral or Written
Reports
A worker who must submit either oral or written reports at specified intervals is probably an employee. Independent contractors may occasionally submit periodic reports but are not usually required to do so.
12. Payment by the
Hour, Week, or Month
Payments made to workers based on commission or by the job usually suggest an independent contractor relationship. Conversely, payments made to workers by the hour, week, or month usually suggest an employer and employee relationship.
13. Payment of
Business and Travel Expenses
An employer and employee relationship is usually characterized by the compensating entity controlling, paying, or otherwise regulating business and travel expenses. This is not the case with independent contractors.
14. Furnishing Tools
and Materials
If the compensating entity provides tools and materials to workers, they are probably employees. However, workers who provide their own tools and materials are probably independent contractors.
15. Significant
Investment
Workers who invest money into facilities to perform a service are probably independent contractors if the facilities are not the kind an employee usually provides, such as an office or building. However, consideration must be given to cases where employees have offices in their homes to the extent that the employer furnishes those offices.
16. Realization of
Profit or Loss
Workers subject to the risk of (or who actually sustain) real economic loss from investments, expenses, and salaries of assistants or hires are probably independent contractors. Employees are not usually exposed to these elements and receive an established specific compensation instead.
17. Working for More
Than One Firm at a Time
Workers who control their own circumstances and can or do work for more than one unrelated entity at a time are probably independent contractors. Employees usually work for one specific employer at a time.
18. Making Service
Available to the General Public
Independent contractors usually have the ability to make their services available to the general public. Employees usually serve only one employer at a time.
19. Right to Discharge
Independent contractors have contractual agreements that guarantee compensation for the contract period as long as they meet the contract's terms and conditions. The compensating entity's right or ability to discharge a person usually suggests an employer and employee relationship.
20. Right to Terminate
Independent contractors cannot be terminated at will. Any termination must comply with the contract's terms and conditions. On the other hand, employees can be terminated at will.
If the employer is still uncertain as to a workers status after reading publications and reviewing the relationships above, it can complete Form SS-8 and ask for the IRS to provide a finding on the status.
The workers compensation law in a particular state may provide guidance as to when a worker is considered an employee. Many state supreme courts have also addressed the issue and established rules to follow in making the determination. The state and the federal guidelines may not always agree. In such a case, the state rules will prevail in a loss dispute because workers compensation law is state-based, not federal.