The Independent Contractor Dilemma

By Philip J. Young

The pros and cons of using independent contractors:

Businesses frequently hire independent contractors for both short and long term projects. Using independent contractors has some advantages, including:

1. Avoidance of the usual employer contributions for unemployment taxes and social security;
2. Avoidance of employee benefits;
3. Avoidance of workers' compensation coverage;
4. Inapplicability of labor law and wage and hour laws normally applicable to employees;
5. Reduced risks of discrimination claims;
6. Eliminating liability for unlawful employment termination suits or unemployment claims on short projects;

However, the downside to using independent contractors includes:

1. Reduced ability to control how the contractor performs the services;
2. Inability to unilaterally terminate the relationship with the independent contractor without risking liability for breach of contract;
3. Monitoring the relationship with the independent contractor to ensure the defensibility of its classification;
4. Potential penalties for misclassifying an employee as an independent contractor.

The difficulty of proper classifications:

Employers often unintentionally misclassify employees as independent contractors. This error can lead to costly and serious consequences, including audits by the IRS and civil lawsuits by the misclassified workers. All employers should carefully review their hiring practices to make sure they are not misclassifying workers. Typically, the inquiry hinges on "control" over the worker.

The IRS generally applies a variety of "control" factors when it determines whether a worker is an employee or an independent contractor. The importance of each factor varies, depending on the occupation and the factual context in which the services are performed. A worker is more likely an employee if a majority of the following apply:

1. He/she is required to follow instructions about when, where and how he is to work;
2. He/she must be accompanied by an experienced employee who must attend meetings, or must be trained through the use of other methods;
3. Services must be rendered personally;
4. The person for whom the services are performed hires, supervises and pays the worker's assistants;
5. A continuing relationship exists between the worker and the person for whom the services are performed;
6. The worker must work set hours;
7. The worker must devote substantially full time to the business of the person for whom the services are performed;
8. The worker performs on the premises of the person for whom the services are performed;
9. The worker must perform services in the order or sequence set by the person for whom the services are performed;
10. The worker must submit regular reports to the person for whom the services are performed;
11. The worker is paid by the hour, week or month;
12. The person for whom the services are performed ordinarily pays the worker's business or traveling expenses;
13. The person for whom the services are performed furnishes significant tools, materials and other equipment;

On the other hand:

1. If the worker invests in facilities used in performing services and those facilities are not typically maintained by employees (such as an office rented at fair value from an unrelated party), that factor tends to indicate the worker is an independent contractor;
2. A worker who can realize a profit or suffer a loss as a result of his services is generally an independent contractor;
3. If a worker performs more than minimal services for a number of unrelated persons or firms at the same time, that factor generally indicates that the worker is an independent contractor;
4. The fact that a worker makes his services available to the general public on a regular and consistent basis indicates an independent contractor relationship;

Conclusion:

Worker classification is important. Businesses may elect to hire independent contractors for a number of legitimate business reasons. However, title alone is not enough. A business which fails to properly classify its workers is vulnerable to unwanted investigation and litigation.