By Michael P. Royal
Many Texas workers have embraced the cowboy mentality of the Wild West and decided they’ll set their own rules, rather than work for someone else. And with Texas’ pro-business climate, this has historically been a very good place for independent contractors to make a good living and help drive our economy.
More than 10 million people nationwide are classified as independent contractors according to the Bureau of Labor Statistics, which represents seven percent of our country’s total workforce. The federal government estimates that 20 to 40 percent of workers are misclassified as independent contractors, as opposed to employees, thus allowing employers to avoid payroll taxes, unemployment benefits, etc. And the number of independent contractors is expected to increase this year as some still struggle to find employment. According to last year’s “Employment Review” from Elance, an online platform for contract employment, 83 percent of small businesses said they plan to satisfy up to half of their workforce hiring requirements with independent contractors in 2012.
To demonstrate its commitment to stepping up its investigative efforts, the IRS is auditing 3,000 employers nationwide in an attempt to address the misclassification issue. State and city taxing authorities – in need of money – are also aggressively challenging workers categorized as independent contractors in an attempt to recover what they perceive as lost revenue.
Though the law is rapidly evolving to address the potential liabilities for all parties concerned, the concept of independent contractors is here to stay. With the increased spotlight on enforcement and proposed legislation to crack down on misclassifications, every employer should reduce their exposure by taking note of their obligations and potential liabilities for contingent workers.
Keep Your Business in the Clear
To be proactive, all employers that utilize independent contractors or other types of contingent workers should prepare for an audit by either the Department of Labor or the IRS to determine, in advance, if any workers have been misclassified.
There is no single test for verifying a worker’s independent contractor status. Rather, the definition varies depending on the legal issue and the agency that may be enforcing the applicable laws. The various tests used to determine independent contractor status, while often similar, sometimes give rise to anomalous results where a worker may be deemed an independent contractor under one legal doctrine, but not another. For example, it is possible for a worker to be deemed an independent contractor for state workers’ compensation purposes, but not an independent contractor for federal tax purposes. Even stranger, a worker may be an independent contractor for federal tax purposes, but not with respect to certain state taxes.
However, the various independent contractor tests have one common denominator—they are all variations of the common law doctrine of “agency.” Thus, one of the overriding factors in each of these tests is which party has the right to control the means and manner of the worker’s performance.
According to the IRS, there are six criteria every employer should analyze when evaluating the classification of a worker as an independent contractor versus an employee.
1. The IRS uses three characteristics to determine the relationship between businesses and workers: behavior control, financial control, and type of working relationship.
Employees are trained to perform services in a particular manner, they must follow specific financial controls set in place by the employer, and they are generally guaranteed a regular wage amount for an hourly, weekly, or other period of time.
In contrast, independent contractors set their own schedules, uses their own methods of work, and are usually paid by a flat fee for the job. A true independent contractor will also finance his or her own benefits out of the overall profits of the enterprise.
2. If you have the right to control or direct not only what is to be done, but also how it is to be done, then your workers are most likely employees.
3. If you can direct or control only the result of the work done – and not the means and methods of accomplishing the result — then your workers are probably independent contractors.
4. Employers who misclassify workers as independent contractors can end up with substantial tax bills. Additionally, they can face penalties for failing to pay employment taxes and for failing to file the requisite tax forms.
5. Workers can avoid higher tax bills and lost benefits if they know their proper status.
6. Both employers and workers can ask the IRS to make a determination on whether a specific individual is an independent contractor or an employee by filing a Form SS-8, “Determination of Worker Status for Purposes of Federal Employment Taxes and Income Tax Withholding,” with the IRS.
In summary, there is no question that employers and independent contractors should obey all local, state, and federal laws as well as pay all taxes required. However, we should also be mindful of any overly broad attempts to arbitrarily reclassify independent contractors and turn them into rank-and-file company employees – merely to enrich the government’s treasury – as such actions could be extremely harmful to those workers who choose this path and play by the rules.
Michael P. Royal is a partner with the Dallas office of Fisher & Phillips LLP, a national labor and employment law firm. He has extensive experience advising and defending employers in a variety of labor and employment matters. You can reach him at mroyal@laborlawyers.com.
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