Contract employees bring unexpected liability
By Louis A. Storrow, Esq.
Many small businesses use "contract employees", people who provide services but are not treated as regular employees. And why not? As an employer, you have to pay unemployment tax, social security, withhold income tax, and maybe you provide medical insurance, vacation, sick leave and other benefits. You're liable for overtime, workers comp insurance, and you're exposed to risks like wrongful termination lawsuits.
With an independent contractor, all you have to pay is the cost of the services, and it's up to the contractor to pay their own taxes and benefits. All you do is pay either an hourly fee or a project fee, and give the independent contractor a 1099 at the end of the year. No muss, no fuss.
Seems like a great solution, but in many cases it can cause bigger problems than it solves. Even if you and the worker agree that he or she is an independent contractor, a government agency or a judge can take that agreement and throw it in the trash if they think the worker is really an employee.
To make matters worse, the rules are different under federal and state law, and under different agency regulations. The IRS looks at 20 factors, the Employment Development Department (EDD) looks at about 10 factors, but in certain industries (like real estate, home health care, computer services, barbering, newspaper distribution, and others) special regulations exist. Take a look at the California Code of Regulations, Volume 22, sections 4304-1 through 4304-12. For wage rules and overtime, the factors are spelled out in cases, like S.G. Borello & Sons v. Dept. of Indus. Relations, a 1989 California Supreme Court case (for you law buffs, it's published at 48 Cal.3rd 341).
If you classify someone as an independent contractor and they turn out to be an employee, you could be liable for withholding, social security and tax payments, but you could also be liable for illness or injuries (because they're not on your health plan or workers compensation policy), and in some cases penalties and fines (even criminal prosecution). You could also be in a situation where a former "independent contractor" is asking you to pay overtime and penalties for missed lunch breaks. I can already hear your protest: "I never asked her to work overtime. I never told him not to take a lunch break. She was an independent contractor, she was responsible for all that!"
I can also hear the agency (whether the IRS, EDD or Labor Commissioner) saying, "You can't make an independent contractor out of an employee just by agreeing to it…. You're liable."
So how do you defend yourself?
The first question is: Who has the right to control the "means and manner" of the work the contractor does every day? It doesn't matter if you don't supervise much, only that you have the right to tell him or her what to do, and when. Does she come to your office, or use her own? Does she have a license to do what she does? Is he in business for himself? Does he work for other people or exclusively for you? Can you end the contract at any time without notice? The more control you have, the more your contractor looks like an employee.
Take an honest look at the job function itself. Is it a normal part of your business or a separate business? Are you contracting for a computer expert to set up the network in your accounting office or are you contracting for a "Word expert" to do your regular typing, filing and general office work? The first example is probably an independent contractor, the second one is probably an employee.
In a close case, get professional advice! Call your attorney or your CPA, but remember the rules are different for tax purposes than for overtime purposes. You can even ask the IRS or EDD for a determination, but they're not guaranteed and won't protect you from a wrong classification. If there's any doubt, you're safer presuming you have an employee. Of course, you may decide to take the risk, but that's your job as a business owner, isn't it?
Lou Storrow is a Carlsbad attorney focusing on employment and business issues. He is past president of the North County Personnel Association and serves as Vice-Chair of Special Projects for the Carlsbad Chamber of Commerce. He can be reached at [email protected]
By Louis A. Storrow, Esq.
Many small businesses use "contract employees", people who provide services but are not treated as regular employees. And why not? As an employer, you have to pay unemployment tax, social security, withhold income tax, and maybe you provide medical insurance, vacation, sick leave and other benefits. You're liable for overtime, workers comp insurance, and you're exposed to risks like wrongful termination lawsuits.
With an independent contractor, all you have to pay is the cost of the services, and it's up to the contractor to pay their own taxes and benefits. All you do is pay either an hourly fee or a project fee, and give the independent contractor a 1099 at the end of the year. No muss, no fuss.
Seems like a great solution, but in many cases it can cause bigger problems than it solves. Even if you and the worker agree that he or she is an independent contractor, a government agency or a judge can take that agreement and throw it in the trash if they think the worker is really an employee.
To make matters worse, the rules are different under federal and state law, and under different agency regulations. The IRS looks at 20 factors, the Employment Development Department (EDD) looks at about 10 factors, but in certain industries (like real estate, home health care, computer services, barbering, newspaper distribution, and others) special regulations exist. Take a look at the California Code of Regulations, Volume 22, sections 4304-1 through 4304-12. For wage rules and overtime, the factors are spelled out in cases, like S.G. Borello & Sons v. Dept. of Indus. Relations, a 1989 California Supreme Court case (for you law buffs, it's published at 48 Cal.3rd 341).
If you classify someone as an independent contractor and they turn out to be an employee, you could be liable for withholding, social security and tax payments, but you could also be liable for illness or injuries (because they're not on your health plan or workers compensation policy), and in some cases penalties and fines (even criminal prosecution). You could also be in a situation where a former "independent contractor" is asking you to pay overtime and penalties for missed lunch breaks. I can already hear your protest: "I never asked her to work overtime. I never told him not to take a lunch break. She was an independent contractor, she was responsible for all that!"
I can also hear the agency (whether the IRS, EDD or Labor Commissioner) saying, "You can't make an independent contractor out of an employee just by agreeing to it…. You're liable."
So how do you defend yourself?
The first question is: Who has the right to control the "means and manner" of the work the contractor does every day? It doesn't matter if you don't supervise much, only that you have the right to tell him or her what to do, and when. Does she come to your office, or use her own? Does she have a license to do what she does? Is he in business for himself? Does he work for other people or exclusively for you? Can you end the contract at any time without notice? The more control you have, the more your contractor looks like an employee.
Take an honest look at the job function itself. Is it a normal part of your business or a separate business? Are you contracting for a computer expert to set up the network in your accounting office or are you contracting for a "Word expert" to do your regular typing, filing and general office work? The first example is probably an independent contractor, the second one is probably an employee.
In a close case, get professional advice! Call your attorney or your CPA, but remember the rules are different for tax purposes than for overtime purposes. You can even ask the IRS or EDD for a determination, but they're not guaranteed and won't protect you from a wrong classification. If there's any doubt, you're safer presuming you have an employee. Of course, you may decide to take the risk, but that's your job as a business owner, isn't it?
Lou Storrow is a Carlsbad attorney focusing on employment and business issues. He is past president of the North County Personnel Association and serves as Vice-Chair of Special Projects for the Carlsbad Chamber of Commerce. He can be reached at [email protected]