National Guardianship Association » Employee or Independent Contractor?

The decision about whether to hire independent contractors or employees can pose complex and at times perplexing issues. A number of different but interrelated factors bear on the question. While the promise of avoided payroll taxes, workers compensation and health benefit premiums may entice an employer to favor the independent contractor characterization, significant risks attend that determination. So the threshold inquiry of whether the contemplated hire would even qualify as an employee is crucial.

In every state, employers who are under an obligation to purchase workers compensation insurance but do not, are exposed to significant penalties. Depending upon the jurisdiction, such penalties could include fines and possible jail time. Often a corporation's executive officers are held personally liable for such penalties. Also, employers who fail to maintain the required workers compensation insurance may be prohibited from conducting business so long as they are not in compliance with the law. Finally, in the event of a claim, the delinquent employer may be precluded from raising any liability defenses. The only question at trial, will be the amount of damages.

From a tax perspective the consequences of having an independent contractor reclassified as an employee are significant as well. The employer may be held responsible for both the employers and employees FICA and FUTA, as well as perhaps the federal income tax on the gross wages paid out to the employee in question. The IRS may also bring in the state and as a result, the employer could also become liable for the state income tax, as well as state unemployment and worker's compensation. Employer's may also face a penalty equal to the amount of the back taxes owed. Likewise, the employer will owe interest on all back taxes from the due dates. And, the business may be required to support the injured person for the rest of their life.

In all jurisdictions, most employees fall within the scope of workers compensation regulation. Business owners, officers and directors may elect whether or not to be covered. Some business owners view workers compensation insurance as inexpensive disability coverage for themselves. However, if they do elect coverage, their benefits are normally restricted to an amount based on an imputed salary level, even if their actual compensation is much higher. Also, if they suffer a disability which is not work related, no coverage would apply.

Several states exempt from regulation employers with fewer than a specified number of employees or annual payroll below a given amount. However, even in these states construction industry employers are subject to workers compensation laws even if they have one employee.

Whether a particular worker is an employee or an independent contractor is central to whether workers compensation laws apply or not. Even so, many state laws provide little guidance to aid in determining whether a particular worker should be categorized as an employee or as an independent contractor. Many state laws are completely silent on this question. A number of statutes simply state that independent contractors are not employees within the meaning of the statute. A few states have specifically spelled out criteria for determining a particular employee's status as an independent contractor or employee. Where the workers compensation statute is silent, normally an employer will have to rely on common law principals to determine the worker's status.

As noted, the employee's classification can also have significant tax consequences. The IRS generally uses the following criteria for making such determinations:

1. Is the worker required to comply with instructions about when, where and how the work is done?
2. Is the worker provided training that would enable him/her to perform a job in a particular method or manner?
3. Are the services provided by the worker an integral part of the business' operations?
4. Must the services be rendered personally?
5. Does the business hire, supervise, or pay assistants to help the worker on the job?
6. Is there a continuing relationship between the worker and the person for whom the services are performed?
7. Does the recipient of the services set the work schedule?
8. Is the worker required to devote his/her full time to the person he/she performs services for?
9. Is the work performed at the place of business of the company or at specific places set by the company?
10. Does the recipient of the services direct the sequence in which the work must be done?
11. Are regular oral or written reports required to be submitted by the worker?
12. Is the method of payment hourly, weekly, monthly (as opposed to commission or by the job?)
13. Are business and/or traveling expenses reimbursed?
14. Does the company furnish tools, equipment and materials used by the worker?
15. Has the worker failed to invest in equipment or facilities used to provide the services?
16. Does the arrangement put the person in a position or realizing either a profit or loss on the work?
17. Does the worker perform services exclusively for the company rather than working for a number of companies at the same time?
18. Does the worker in fact make his/her services regularly available to the general public?
19. Is the worker subject to dismissal for reasons other than non-performance of the contract specifications?
20. Can the worker terminate his/her relationship without incurring a liability for failure to complete the job?

1. You must file 1099 miscellaneous income forms (if over $600)
2. Similar workers must be treated alike (not treated as employees)
3. There must be a good reason for the contractor status
   1. Precedent: court cases and revenue rulings
   2. Practice: long standing in the industry
   3. IRS previous audit