Time to Revisit Your On-Boarding Policies Regarding Independent Contractors

Time to Revisit Your On-Boarding Policies Regarding Independent Contractors

Recently, states have been entering into joint efforts with the US Department of Labor to identify employees who are misclassified as independent contractors. This has been a hotbed issue for the past few years, however, with the assistance of the U.S. DOL, this issue will only become more prevalent, allowing for more investigations and more companies, in all industries, to be audited.   

Why should employers be concerned? In many instances, employers seek to characterize a worker as an independent contractor instead of an employee so they can avoid paying payroll taxes, unemployment insurance, worker’s compensation, retirement benefits, paid time off, and health insurance. This makes business sense and in the right circumstances the business arrangement may be structured in a way that supports the independent contractor classification.  

Each state utilizes its own test to determine whether a worker is properly classified as an independent contractor, however, most states have aspects of their test in common.

Common aspects of the test to determine whether or not someone is an independent contractor include:

  • Whether the individual free from control or direction over the performance of such service; and
  • Whether the service performed by the individual is the regular service of the employer’s business; and
  • Whether the individual is customarily engaged in an independently established trade, occupation, profession or business.

Due to the agreement and actual relationship of the parties, oftentimes employees are misclassified as independent contractors and penalties are imposed. Simply put, misclassifying employees as independent contractors could lead to potentially significant consequences, such as liability for back taxes, penalties, and overtime pay (and possibly attorney’s fees to misclassified workers).

So how do you make sure you are on the right side of an audit and avoid the potentially damaging consequences of a misclassification? The most crucial step in the process is to design an onboarding procedure that accounts for as many factors as the applicable law suggests in determining whether a worker is an independent contractor. While this may vary slightly from state to state, auditors will typically look at whether:

(1) The contract is for a specified time period (if at-will then suggests an employee-employer relationship)
(2) The contractor can work for other clients (limiting a contractor’s right in this regard suggests an employee-employer relationship)
(3) The contractor has multiple clients/sources of income
(4) The contractor has business insurance
(5) The contractor assumes the risk of non-payment in the event the client’s client does not pay
(6) The contractor has business letterhead/cards/etc.  
(7) The contractor has an EIN
(8) The contractor has billing policies/protocols
(9) The contractor markets the company
(10) The contractor maintains corporate books and records
(11) The contractor has dedicated business phone lines, and
(12) The contractor has properly filed taxes

(This is not intended to be an exhaustive list and is for illustrative purposes only.)  

Typically, when hiring an independent contractor you want to ensure all of the foregoing as well as make sure you are dealing with a corporation. If a contractor is a corporation, it goes a long way with the auditor.

If you are concerned or have questions whether you have or are properly classifying your employees/independent contractors, please reach out to your legal counsel for advice.