Know the Rules: Expanding your Business with
Independent Contractors
Congratulations! You are ready to expand
your business in a big way, and have started interviewing
people to put together the team to support you, but you are
concerned about incurring big up-front costs for unemployment
or workers’ compensation coverage. You think you want your
workers to be classified as Independent Contractors, but how
can you ensure that they will be?
There are a variety of
laws that govern whether a worker is an independent contractor
or an employee, and different agencies have different ways of
looking at the issue. If you want to avoid problems such as
fines and taxes, you will need to know the rules of all of the
affected agencies before you hire a new worker, and
preferably, before you begin the interviewing process.
For
most businesses, the most important classification rules which
must be met are those of the Internal Revenue Service. Under
the IRS’ test, workers are considered employees if the company
they work for has the right to direct and control the way they
work, including the details of when, where and how the job is
accomplished. The IRS will consider workers independent
contractors if the company they work for does not manage how
they work, except to accept or reject their final results.
The IRS looks at a number of factors when determining
whether the worker is an employee or an independent
contractor. The agency is more likely to classify a worker as
an independent contractor when he or she:
• Can earn a
profit or suffer a loss from the activity;
• Furnish the
tools and materials needed to do the work;
• Is paid by the
job, rather than on an hourly or periodic basis;
• Works
for businesses in addition to your business during the same
time period;
• Invests in his or her own equipment and
facilities;
• Pays his or her own business and traveling
expenses;
• Hires and pays assistants to whom specific
tasks or operations are delegated at the discretion of the
contractor; and
• Sets his or her own working hours.
In
contrast, the IRS is more likely to determine that a worker
who meets the following criteria is an employee, rather than
an independent contractor:
• Can be fired at any time by
the hiring firm;
• Is paid by the hour, or another periodic
basis;
• Receives instructions from the hiring firm;
•
Receives training from the hiring firm;
• Works full time
for the hiring firm;
• Receives employee benefits;
• Has
the right to quit without incurring liability, i.e., the
worker’s provision of services is “at will”; and
• Provides
services that are an integral part of the hiring firm’s day to
day operations.
If you are fairly certain that the IRS
would consider the worker an independent contractor, you would
not be required to withhold federal payroll taxes for the
worker, including social security taxes, federal disability
taxes, and federal income taxes. If the IRS would not consider
the worker an independent contractor, then you should withhold
these taxes. In addition, you may have responsibility for
paying a portion of the social security taxes on the worker’s
wages.
In a state, such as California, that collects state
income tax, a company must also be familiar with the State’s
tax department rules regarding independent contractors. As
with the IRS, if the worker qualifies as an independent
contractor under the state’s tax department test, you would
not be required to withhold state income taxes for money that
is paid to the worker. Otherwise, the company should withhold
state taxes, even if the worker qualifies as an independent
contractor under other tests.
If the worker meets the
State Unemployment Compensation Board’s definition of
independent contractor, then you will not be required to pay
for unemployment insurance for that worker. If the worker does
not meet this test, you will be required to provide
unemployment coverage for the worker, even if the worker
qualifies as an independent contractor under tests used by
other agencies, even the IRS.
If a worker meets the State
Workers Compensation Agency definition of independent
contractor, you will not be required to pay for workers
compensation coverage for that worker. Otherwise, you will be
required to pay for workers compensation coverage, even if the
worker qualifies as an independent contractor under other
tests.
The issue of whether your worker will be entitled
to workers compensation insurance while working for you is a
key issue that could effect your bottom line. If a worker you
consider an independent contractor injures himself on a job
and applies for workers compensation – something reserved for
employees – you may find that your business will be audited by
the State Workers Compensation Board. In addition, you may be
faced with liability for medical costs and lost compensation
that would have been covered by workers compensation
insurance. Again, documentation from the inception of the
relationship between your company and the worker to prove that
the worker was an independent contractor under the workers
compensation board’s test is needed before the worker is
hired.
Both the US and California Departments of Labor
have regulations concerning whether a worker is an independent
contractor. Depending on the test, the obligation to pay
worker overtime may not be triggered.
Protect your
business from taxes, fines, and unwanted liability by knowing
the rules. Discuss your plans for the independent contractor,
his or her work duties and any potential wrinkles that affect
your specific business with an employment attorney. A modest
fee up front to get the right advice can protect your business
from extensive fines and liability down the road.
Irena Leigh Norton is a partner with Shulman Hodges
& Bastian LLP, a full service business law firm with
offices in Foothill Ranch and Riverside, California. She can
be contacted at inorton@shbllp.com or
951.275.9300
The information contained in this article
is general in nature, and does not constitute specific legal
advice, and does not create any attorney-client relationship
or obligations with any person receiving the article.
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