The High Cost of Misclassifying Employees as Independent Contractors: A Comprehensive Guide - Part 2

The Challenge of Determining Employment Status

Determining whether an individual is an employee or an independent contractor can be a complex process. Government agencies do not provide a single, definitive test to make this determination. To complicate matters further, an individual may be considered an independent contractor by one agency and an employee by another.

The IRS/Common Law "Control" Test

The Internal Revenue Service (IRS) uses the common law "control" test to determine employment status. This test considers 20 factors, none of which are definitive on their own. Instead, the IRS balances these factors to determine the overall employment status. These factors include:

• The worker's ability to profit or suffer a loss from the activity.
• The location where the worker is told to work.
• The worker's availability to the general public.
• The worker's ability to be fired by the hiring firm.
• The worker's provision of tools and materials needed for the work.
• The worker's payment method (by the job or by the hour).
• The worker's employment with more than one firm at a time.
• The worker's ongoing relationship with the hiring firm.
• The worker's investment in equipment and facilities.
• The worker's payment of their own business and traveling expenses.
• The worker's right to quit without incurring liability.
• The worker's receipt of instructions from the hiring firm.
• The worker's receipt of training from the hiring firm.
• The worker's personal performance of the services.
• The worker's hiring and payment of assistants.
• The worker's setting of their own working hours.
• The worker's provision of regular progress reports to the hiring firm.
• The worker's full-time work for the hiring firm.
• The worker's provision of services integral to the hiring firm's operations.

Other Government Agencies

Other government agencies to consider include your state Unemployment Compensation Board, Workers' Compensation Insurance Agency, Tax Department, and Department of Labor. Each agency has its own approach to determining employment status, often focusing on a few key factors from the "control" test. It's crucial to understand these factors before hiring independent contractors. Most of this information can be found on the agency's website or by contacting them directly.

Protecting Yourself from Misclassification

Understanding the difference between an independent contractor and an employee, as well as the risks of misclassification, is the first step in protecting yourself.

Independent Contractor Agreement

Arming yourself with the IRS' control test factors and the tests used by your state's government agencies is crucial. Once you have this information, you can structure your arrangements with your independent contractors accordingly. These arrangements should be documented in an independent contractor agreement, which can serve as valuable evidence in proving the worker's independent contractor status.

Screening Process

Before hiring an independent contractor, it's advisable to conduct a thorough screening process. This can include a questionnaire to gather information that supports the worker's status as an independent contractor. Examples of such information, courtesy of the NOLO website, include:

• The worker's legal business entity.
• The worker's fictitious business name (also known as a "DBA" or "doing business as").
• The worker's business address and telephone numbers.
• The number of employees employed by the business.
• The worker's professional or business licenses.
• References from other businesses for whom the worker has performed services as an independent contractor.
• The worker's business marketing methods.
• The worker's separate office from their home.
• A description of the equipment and facilities the worker owns and will use in the project.
• The worker's business cards and stationery.
• A listing of the types of insurance coverage the worker has for their business.

Requesting documents that evidence the responses to these questions can further support the worker's status as an independent contractor.

Ultimately, the decision to hire an employee or an independent contractor is up to you and your business. If you feel confident in managing the relationship to protect yourself from misclassification allegations, the independent contractor route may be the best choice. However, if you're unsure, it may be safer to hire an employee, even if it's more expensive upfront. Misclassification can result in back-taxes, interest, and penalties, so it's crucial to make the right decision.