Earlier this week, I had a coversation with a client who mentioned a problem with employees classified as independent contractors. I realized that this is a situation that goes on pretty often — that people are classified as independent contractors when, in reality and under the eyes of the law, they're technically employees. A misclassification like this could have dire consequences down the road. Here in Massachusetts, courts use a three-pronged test to determine if, 1) the person has a certain level of freedom and independence to complete the task, 2) the task is not something the company ordinarily does in the course of business (so they have to contract out to get it done), and 3) the individual is normally engaged in the type of business they’re contracted for. Let me explain how this plays out in real life.
Employees are people who work for your company. They are employed by you. You tell them when to show up and when to stay home. You tell them exactly what to do for their job and when it must be completed. You cut them regular paychecks.
When someone is classified as an employee, the employer has certain responsibilities to fulfill. These responsibilities include paying into social security (the employer’s portion), paying into disability insurance for the state (I’m in Massachusetts), enforcing wage garnishments from paychecks, and potentially providing health insurance pursuant to the Affordable Care Act (i.e. Obamacare).
Your average employee has a relatively small amount of freedom and independence in their job ranging from very little to moderate, and the employer retains control over various aspects of the details of job performance and duties. Having employees can be expensive, which is why many people (especially tech startups) seek to classify their workers as independent contractors.
An independent contractor differs from an employee in many ways. First and foremost, an independent contractor remains relatively unsupervised by the person who hired her to complete an assignment. Essentially, the assignment and end goal is explained and agreed upon, a price is determined, and a final deadline is set. At this point the independent contractor goes about her business and returns by the deadline with the finished product according to whatever specs were agreed upon in advance. Already seeing the differences between an independent contractor and an employee?
An independent contractor is not required to regularly show up to the company (unless the task must be completed on company grounds and during specific intervals out of objective necessity), nor are they required to clock in and out at specific times. They typically are not assigned to various tasks and matters by the hiring agent and instead contract to do work on a specific project. They may contract to work on several specific projects, but each one is generally treated as independent of the other. They do not take a salary and remain free to work with other organizations and on other projects as long as they do not interfere with the completion.
Independent contractors are responsible for paying their own self employment taxes, getting their own health insurance, and are otherwise recognized as little independent companies that work with other companies. Think of a Startup developing an app who tells Joe Programmer to write and develop some vector graphics (something Startup doesn’t do) and agrees to pay him $1,000 for that work. They discuss what graphics are needed, the format to be delivered in, and when they are due. The Startup then receives the needed work from the programmer in a couple of weeks, as agreed, makes sure they’re satisfactory and made as discussed, and then writes a check.
Independent Contractors are NOT Employees
The problem comes when people work as employees, are treated as employees, are held to the same expectations of employees, but are then classified by the employer as independent contractors. Slapping a label on someone and their work does not make it so. There are statutory definitions that have been fleshed out through caselaw that prevents this.
However, it happens every single day. Using the scenario from above, it would look something like:
Startup interviews various ‘contractors’ for a programming position. Startup chooses a contractor and describes various tasks to be done. Contractor is expected to be in the startup’s office working on the tasks, supervised, on a regular basis. Once one task is complete, another one is given. The contractor receives a compensation check every other week.
In that situation, they may be calling the person an independent contractor, but for all intents and purposes they’re an employee who doesn’t get any benefits or employee tax treatment.
But here’s where it goes wrong -
“contractor” is terminated from her contract and she seeks to collect unemployment by having her time with the company classified as employment, and the government agrees with her. The company is hit with penalties and interest on however many years of unpaid employment taxes, unemployment payments, health insurance premiums and penalties under the ACA, and of course the potential audit of all other “contractors” for the same set of penalties.
Misclassifying your workers, while cost efficient in the short term, could have devastating consequences later. All it takes is one soured relationship to potentially bring a thriving company to its financial knees. Consider the tax burden alone for 20 employees over 5 years who were misclassified.
What to Do?
Check with an attorney to determine if your workers are employees or contractors. Then work to insure that contractors are treated as such. If that can't be done, then it may be time to get a payroll company to handle the withholdings and do things properly.