So, you’re starting (or thinking of starting) a new business. Or maybe your business has been open for awhile and you’re looking to hire your first “real” employee. Either way — what an exciting time!
Whether you’re actually at the point of posting a job listing or you’re just contemplating getting your venture off the ground, it will pay to keep a few personnel-related issues in mind.
Could you have employees without knowing it?
Many small businesses start off with outside contractors or consultants before moving to hiring full-time employees. This can be a great way to get some help when your business is too big for you to run alone, but not big enough yet to support a full-time workforce.
A problem arises, though, when those outside contractors turn out, legally speaking, to be employees. Many business owners mistakenly think all they have to do is sign a contract that stipulates the worker is an “independent contractor (IC),” and they’re covered. In fact, there are legal criteria that have to be met for a worker to be considered an IC. If the job doesn’t meet the criteria, they’re an employee.
Misclassification can result in big fines and penalties, not just from the Department of Labor (DOL). Several years ago the DOL started a Misclassification Initiative, through which agencies in at least 37 states, the DOL, the IRS, and other federal agencies are cooperating and sharing information about employers who are found to have misclassified workers.
What makes this issue especially confusing (and frustrating) for employers is that these various agencies don’t seem to agree on the details of the criteria that must be met to classify a worker as an IC. The IRS considers several “Common Law Rules” divided into three categories, while the DOL lists six criteria on their Misclassification Fact Sheet. Several courts have chosen to rely on an “economic realities test,” while many state agencies have their own standards.
Further, looking over the standards, you’ll see there are no “hard and fast” rules. Whether a worker is classified as an employee or a contractor usually comes down to a matter of degree. As the IRS website states:
…There is no “magic” or set number of factors that “makes” the worker an employee or an independent contractor, and no one factor stands alone in making this determination. Also, factors which are relevant in one situation may not be relevant in another.
The keys are to look at the entire relationship, consider the degree or extent of the right to direct and control, and finally, to document each of the factors used in coming up with the determination.
How about some examples?
OK, since I’m a webmaster, let’s go with an example I’m familiar with — let’s say you want a new website for your business.
You can have some say over the timing of the work. You can specify in your contract with the web designer that you need your new website up and running within three months. It doesn’t matter if they do the work themselves or if they subcontract the work out to someone else. And it doesn’t matter if they do some work every day for the next three months, or if they save it all for a marathon “death march” starting two weeks before the deadline. As long as they get your spiffy new website posted before the deadline, they’ve met the contract terms. If they did a good job of estimating their costs when bidding the contract, they make a profit. If they didn’t do such a good job, they could experience a loss.
Under these terms and conditions, the web designer would most likely be considered an IC.
But if you require the webmaster to come in to your office and put in a few hours every day working on the new site design, so you can review and comment on the work-in-progress, it becomes more likely they would be considered an employee — especially if you specify exactly which and how many hours they’re supposed to work each day. The probability of employee classification goes up if you insist they use a computer and software you supply, and don’t allow them to do any work on their own equipment off-site. If you insist they can’t subcontract the work on your site but have to do it all themselves, it becomes even more likely. If on top of all that you’ve agreed to pay them by the hour, so there’s no possibility of them experiencing a loss on the deal, it becomes a virtual certainty they’re going to be classified as an employee.
Your best bet? Consult with a labor law attorney before you hire anyone you want to consider an IC to make sure the way you’ve structured the job meets not only the IRS and DOL criteria, but also any additional criteria that your own state may impose. Seriously, this is not a job for an amateur, no matter how experienced you may be.
What’s else do you need to do before hiring?
Okay, so you’ve consulted with your attorney and made sure all the positions for which you want to hire have been properly classified. Now you’re ready to run out there and start interviewing candidates, right?
Not so fast, grasshopper! Next time, we’ll talk a bit about the one document you really need if you’re hiring an IC, and the three pieces of documentation should should have ready to go before you hire your first “real” employee.
In the meantime, share your thoughts! Have you had any experiences with worker misclassification — either as an employer or as a worker? Have you got any additional tips or resources to help clear up the classification confusion?