Are Your Independent Contractors Really Employees?Under Some Laws They Will Be Treated As Such

Employee versus independent contractor status is not only an issue with respect to classification for IRS purposes, but with respect to classification under other laws as well.

Many employers improperly classify people who are really employees as independent contractors for IRS withholding purposes. If mis-classification comes to light during an audit of either the employer or the worker, of if the worker fails to pay taxes, the employer can subject to penalties. Additional penalties may also be imposed if the worker who was mis-classified as an independent contractor turns out to really be a nonexempt employee under state and federal wage and hour laws.

Additionally, many employers are not aware that there are different tests for whether a worker is an independent contractor or an employee, depending on the type of law applied. For example, independent contractors have many of the same rights as employees under state and local anti-discrimination laws. The reverse is also true – sexual harassment or racial or other forms of discrimination initiated by an independent contractor could result in liability to the employer. Additionally, concepts of agency may result in the employer being bound by the words of acts of the independent contractor, such as verbal or written commitments to buy and sell goods or services at a certain rate, or liability for auto accidents.

From the IRS’ perspective, there is no “bright line” test for determining whether a worker is an independent contractor or an employee. The IRS looks at three categories of evidence –Behavioral Control, Financial Control and the Type Of the Relationship itself. According to IRS Tax Topic 762, Behavioral Control covers facts that show whether the business has a right to direct and control how the work is done, through instructions, training or other means.

Financial Control covers facts that show whether the employer or business has a right to control the business aspect of the worker’s job. This includes:

  • The extent to which the worker has unreimbursed business expenses,

  • The extent of the worker’s investment in the business,

  • The extent to which the worker makes services available to the relevant market,

  • How the business pays the worker; and

  • The extent to which the worker can realize a profit or incur a loss.

Facts covering the Type of Relationship include:

  • Written contracts describing the relationship the parties intended to create,

  • The extent to which the worker is available to perform services for other, similar businesses,

  • Whether the business provides the worker with employee-type benefits, such as insurance, a pension plan, vacation pay, or sick pay, and

  • The permanency of the relationship.

Even if a worker meets the independent contractor test set forth by the IRS, employers should keep in mind that under most circumstances, they will be liable for sexual harassment or discrimination by the independent contractor. To address these issues, employers may wish to consider insuring this risk, or requiring independent contractors to provide certification that they have been trained in sexual harassment and discrimination. Requiring the independent contractor to go through employer-provided sexual harassment and discrimination training, however, could negatively affect the “behavioral control” part of the independent contractor test. Thus, requiring that a person have this kind of training already as one of the qualifications for being an independent contractor may be more prudent. Additionally, an agreement requiring the independent contractor (and his or her employer, if any) to indemnify, defend and hold you harmless from any such claims will also provide some protection, if the independent contractor is solvent.

As for being bound by the words and acts of an independent contractor under an agency theory, be sure that anyone who comes under contract with the independent contractor knows the scope of the independent contractor’s authority to speak and act on your behalf. If it appears that you have given the independent contractor carte blanche to act and speak for you, you may have inadvertently increased the apparent scope of the independent contractor’s authority beyond what you intended.

Specific legal problems need specific solutions. This article is for general discussion purposes only and should not be relied on for any purpose, and does not necessarily represent the views of the author. This article is not legal advice, and does not create an attorney-client relationship.