Many small businesses utilize independent contractors rather than hire full-time employees.
While this approach has many positive aspects, there are pitfalls to avoid.
A Florida labor and employment lawyer, Paul O. Lopez, offers advice and cautions to business owners who are deciding whether to classify certain workers as employees or independent contractors.
Business owners and companies are constantly on the lookout for ways to reduce costs. One simple way to do so is for companies to reduce the FICA and payroll taxes they pay in connection with their workers.
Unfortunately, many business owners and companies try to avoid paying these taxes by misclassifying their workers as independent contractors, and then face the consequences of an IRS audit and subsequent fines and penalties. To avert this, companies need to ensure that their independent contractors are truly "independent," as defined by the IRS.
To determine whether a worker is an independent contractor or an employee, the IRS scrutinizes the relationship between the business and the worker. In sum, the IRS test is about control. The IRS examines the level of supervision that the business has over what the worker does, and the ability of the employee to carry out his duties as he sees fit. Generally, the IRS looks at three broad categories: the general relationship between the parties, the level of control over the worker's behavior, and the financial control exerted over the worker. Titles and classifications are largely irrelevant in this analysis; the actual day-to-day dynamic between the company and the worker is the lynchpin.
Behavioral control concerns the ability of the business to control how work is performed. Must the worker perform tasks in a predetermined manner, or does the worker carry out his duties without someone looking over his shoulder? Financial control generally concerns the extent to which the worker is financially tied to the business. If the worker is free to work for other businesses, and is not reimbursed for all his expenses, this will likely support a finding that the worker falls into the independent contractor category.
The relationship between the parties is also examined. Various factors are reviewed. For example, how the parties perceive their relationship or how they have defined it contractually is a factor, albeit minor, to consider; the type of benefits a worker receives; the importance of the work performed in relation to the business; and how permanent the relationship is. These are just some examples that the IRS will take into account.
None of the factors above conclusively establish a worker's categorization; it is better understood as a "balancing test." If the balance is clearly in favor of an employee status, then categorizing a worker as an independent contractor is a poor choice that may lead to serious penalties. If the factors could arguably support either categorization, then an employer may have a "good faith" ability to classify the worker as an independent contractor. Even this situation could be risky, however, because if the business has treated another similar employee as an employee in the past, the IRS can impose taxes and possibly fines on the business.
Because of the pitfalls associated with choosing to categorize a worker as an independent contractor, a business owner should tread lightly. If a business owner has questions concerning whether categorizing a worker as an independent contractor can be done in good faith, they should contact an attorney experienced in labor and employment law.
Thanks to Paul O. Lopez, Director of the Fort Lauderdale, Fla., law firm Tripp Scott, P.A.. Lopez heads up the law firm's Labor and Employment Department.