Some companies are using independent contractors rather than hiring full-time employees. The reasons are simple: it saves costs and limits liability. Independent contractors generally do not get health and retirement benefits, their actions do not necessarily expose the employer to liability and employers do not need to make tax contributions or withholdings for payments to them. In addition, most anti-discrimination statutes offer no protection to independent contractors and employers need not secure workers compensation insurance for these individuals.
“From an employer’s perspective, retaining or classifying individuals as independent contractors appears to be a no brainer,” said Damian C. Shammas, counsel to Porzio, Bromberg & Newman, P.C., Morristown, New Jersey. “However, in an effort to increase revenues in tough economic times, both federal and state governments are dedicating significant resources to investigate such classifications. More employees mean greater tax revenues and greater employer costs. Good news for governments; bad news for employers.”
Earlier this year, the Internal Revenue Service (IRS) streamlined the analysis used to determine whether an individual is an employee or an independent contractor, according to Eric L. Probst, a principal with the same law firm. Specifically, when examining the relationship between the worker and the business, “all informa-tion” regarding the “degree of control and the degree of independence must be considered.” The IRS’s evaluation framework is divided into three categories:
- behavioral control;
- financial control; and
- the parties’ relationship.
The behavioral control category focuses on the ability of the business to direct and control the worker’s performance of the job, noted Shammas. The IRS considers:
- whether the business gives the worker instructions about when and where to perform the work;
- the tools or equipment to be used;
- the workers to be hired or used to assist in performing the work;
- where supplies and services should be obtained;
- the work that specific individuals should perform; and
- the order or sequence of tasks that the worker must follow.
Shammas explained that consideration is also given to whether the business provides training to the worker regarding how services should be performed. According to the IRS’ guidance: “The key consideration is whether the business has retained the right to control the details of a worker’s performance or instead has given up that right.”
Probst asserted that the second category of the analysis entails an assessment of the business’s financial control over the worker’s job. The IRS considers:
- whether the worker has unreimbursed expenses;
- the worker’s investment in the facilities used to do the job;
- whether the worker makes his services generally available; and
- how the worker is paid.
Employees are not likely to have unreimbursed expenses, according to Probst. “They also generally do not have a significant investment in the facilities and lack freedom to explore opportunities to perform the work for other businesses,” he explained. “Moreover, employees are usually paid on the basis of their time spent working, i.e., by the hour, week, month or year, instead of by the task or project. In addition, employees normally do not generate a profit or realize a loss.
The third and final part of the analysis involves an assessment of the relationship between the worker and the business. Shammas’ pointed out the factors to consider including:
- whether any written contracts exist that describe the parties’ intended relationship;
- whether the type of benefits normally provided to an employee are given to the worker;
- whether the relationship is intended to be temporary or permanent; and
- how integral the services provided are to the business.
However, the existence of a written contract that classifies the worker as an “independent contractor” is not a final decisive outcome.
If your company is currently using independent contractors and there could be a classification problem in the IRS’ eyes, check with a lawyer knowledgeable in this area of taxes and the law. Shammas and Probst said that the lawyer can look at the relationship between the independent contractor and the employer, and, if necessary, suggest changes that an employer can make to its relationship with workers to minimize the risk of a classification problem.
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Porzio, Bromberg & Newman, P.C.