Many companies are looking for ways to get more people on board without raising costs in the current economy. One way that many companies do this is by hiring independent contractors instead of employees. However, there can be a lot of legal consequences if you misclassify your workers as contractors when they should be considered employees. In this blog post, we will discuss what constitutes an employee and avoid being legally liable for misclassification.
Legally speaking, an employee is anyone who performs services for and under the supervision and control of another as a partial or complete substitute for the other’s labor. That means two factors must be true:
(1) The individual is customarily engaged in an independently established trade, occupation, profession, or business; AND
(2) The individual has control over how they do their work.
This definition often includes independent contractors since they are generally considered to be doing work on their own rather than under your direction. However, there are situations where it can make sense to classify someone as an independent contractor instead of an employee, even though they might meet this definition. For example, if a construction company hires subcontractors, it may be more affordable to classify the workers as independent contractors rather than employees.
For an employer, there are several potential problems with misclassifying an employee as an independent contractor. First, employers must pay their share of payroll taxes for employees. Suppose you hire someone working 40 hours per week. In that case, that means 30% goes to Social Security and Medicare taxes (6.2% each), plus your share of FICA taxes (1.45%), unemployment insurance (0.8%), and other state and federal agencies for total tax rates around 15%.
This is just the employee’s portion; these deductions do not include your share. Since independent contractors are responsible for their own payroll tax deductions, you will save by hiring them instead of employees. Second, companies must provide 1099 to their independent contractors. The 1099 states the income they received from the company so they can report it on their taxes. While you do not have to send 1099 with an employee’s annual earnings, if they have multiple sources of income and reach the minimum threshold for being required to file a tax return ($400), then you must send them a W-2. In addition, most employees receive compensation that includes items such as health benefits, sick leave, and paid time off, which are not included in your payment to an independent contractor.
It is important to note that misclassifying employees as independent contractors are not only a legal issue; it can also affect your moral standing as a company. If you hire people and treat them as contractors who do not receive the same benefits you offer your employees, then workers may feel like they are being cheated. This can lead to resentment and even sabotage company property or information, which can be very costly.
For companies that want to avoid legal problems with their contractor status, it is important they give these workers the freedom to control the means and methods of completing their work. Suppose an individual has more than one client at a time. In that case, they must also perform services personally (i.e., not delegate those tasks) for those firms to qualify as independent contractors rather than employees.
Finally, even if you pay someone as an independent contractor but fail to meet all of the criteria above, you may still be liable for damages under the common law theories of agency or employment by estoppel if it is later determined that they were improperly classified. Thus, establishing independent contractor status can help avoid many legal problems and increase your company’s profitability.