April 15 looms ominously close, the topic of government-sponsored theft rears its ugly head yet again. As if the fact that most Americans will work until April 30 this year to pay their tax liability1 isn’t painful enough, headlines, print media and even dinner table conversations serve as ugly reminders of that American tradition you just cannot avoid—paying taxes.
So, April seems like the perfect month to address an employment law issue steeped in the holiest of capitalistic American customs: avoiding taxes. I’m referring to the time-honored tradition of using independent contractors to lower payroll taxes for your company and income taxes for the employee—uhh, I mean, contractor. (Oops.)
Every blissfully ignorant employer wielding a 1099 like it’s a bullet proof vest needs to duck for cover, because reporting earnings on a 1099 does not an independent contractor make.2 Remember, this involves taxes—nothing is simple. If it were simple, we wouldn’t need accountants.3 And, if you get it wrong, you can be on the hook for overtime, minimum wage, tax withholdings, the employee’s portion of the taxes, benefit plan contributions and the hits just keep on coming. Liability isn’t limited to suits by an employee; it can be by government audit or your workers’ compensation insurer. Trust me, you don’t want to mess this up.
First, you should be aware that the determination of one’s status as an “independent contractor” or an “employee” isn’t made by reference to any one event, label, title or circumstance. Instead, there are a number of different “tests” that incorporate different “factors” to determine status. And, to make matters worse, which “test” and “factors” you use depends on which governmental agency is coming after you. So, there’s the test for the IRS. Then there’s the test for the EDD. Then there’s the test for worker’s compensation (which the EDD thinks is its test, but really isn’t). Then there’s the test used by the Department of Labor and the test used by the California Department of Labor Standards Enforcement.4 As a result, an individual could be deemed an “employee” by one agency for its purposes and an “independent contractor” by another agency for its purposes.5
Second, you can’t simply agree that someone is an independent contractor any more than you could agree not to pay minimum wage or overtime. (If you think you’re doing the latter, call someone for help.) And those written “independent agreements” you downloaded from the Internet or got from your buddy aren’t particularly useful either. They’re only helpful if they accurately reflect the terms of your relationship with the worker, and even then, only if those terms make it look like the individual is an independent contractor. Otherwise, the agreements generally aren’t worth the paper they’re written on.6
Third, just because a worker performs services for you for some, but not all of the week, doesn’t mean they’re an independent contractor. We have another name for those folks: “part-time employee.” Even if they work for other companies (sometimes called “working two jobs”).
What you can take from this is there’s no single, readily determinable circumstance that results in a worker being properly categorized as an independent contractor.
But the rub on independent contractor status isn’t all bad. There are many relationships with workers that can be appropriately categorized as “independent” that will allow an employer all those benefits of payroll tax avoidance, reduction in benefits and lowered workers’ compensation premiums. And, regardless of which “test” is ultimately used, there’s a shorthand phrase that lies at the heart of the analysis: Who controls the manner and means by which the work is performed? If the worker is in business for him or herself, decides how to do the job, when to do the job, who does the job and is only responsible to the employer for the final product, the relationship has a chance of being appropriately categorized as independent.
Now for the cautionary notes:7 This shorthand test doesn’t mean an employee who’s otherwise controlled by you but has lots of discretion is an independent contractor. Additionally, any time alleged independent contractors are performing the exact same services that are performed by your own employees (especially those employees who perform the core function of your business), calling themselves independent contractors will quickly raise red flags. Keep in mind that the hallmark of truly independent contractors is one where the workers are actually in business for themselves, and hold themselves out to the general public for that purpose.8
Spending a few minutes reviewing your working relationships to see if they’re truly “independent” might be the best tax move you make this year.
1 In California, the date is actually May 7. Seriously. It’s called “Tax Freedom Day.” If you don’t believe me, check out http://articles.moneycentral.msn.com/Taxes/Advice/YoullWork4MonthsJustToPay
Taxes.aspx.
2 But I hear they make great paper airplanes!
3 And if we didn’t need accountants, what would people with an overdeveloped accuracy level on a 10-key do for a living?
4 And so on and so forth. You get my point, right? There are lots of tests.
5 Governmental schizophrenia at its finest.
6 Back to that paper airplane thing again. By the end of this article, you may want to consider advanced origami.
7 More of a disclaimer, actually. Did you think you’d get good news from an attorney without a disclaimer? Rookie.
8 If you don’t want to sift through the mountains of cases explaining the different tests and instead want a quick glimpse of the types of factors looked at by the various agencies, I suggest the IRS 20-factor test. You can download it at http://www.uschamber.com/sb/business/P07/P07_1115.asp
