I recently provided five of my top HR tips to a local magazine. My No. 4 tip was “Don’t misclassify employees as independent contractors to avoid payroll taxes or worker’s compensation insurance. Violations of wage and labor laws can result in costly fines and penalties.”
We work with small businesses every day, and the independent contractor classification is frequently misused. It is understandable since one of the biggest expenses for many small business owners is payroll related.
It is so much easier and cheaper to 1099 individuals at the end of the year and have no formal employees, but that can lead to big trouble if it is wrong and you get caught.
An unfortunate example of this was a situation where a small business experienced a downturn and had to let some people go. One of the “independent contractors” tried to file for unemployment benefits. The claim was investigated, and it was rightly decided this person was an employee.
The owner was forced to pay the employment taxes they should have been withholding and paying for all of the “independent contractors” in addition to multiple fines, penalties and interest. You can imagine how costly this was, and the owner almost lost his business entirely.
The IRS uses three characteristics to determine the relationship between businesses and workers:
• Behavioral control covers facts that show whether the business has a right to direct or control how the work is done through instructions, training or other means.
• Financial control covers facts that show whether the business has a right to direct or control the financial and business aspects of the worker’s job.
• Type of relationship factor relates to how the workers and the business owner perceive their relationship.
The IRS has a helpful publication that can be found at http://www.irs.gov/pub/irs-pdf/p15a.pdf.
Section 2 goes into greater depth on the three characteristics and even gives examples from various industries.
The SBA has its own version of this. They say an Independent Contractor:
• Operates under a business name,
• Has his/her own employees,
• Maintains a separate business checking account,
• Advertises his/her business’ services,
• Invoices for work completed,
• Has more than one client,
• Has own tools and sets own hours, and
• Keeps business records.
And an employee:
• Performs duties dictated or controlled by others,
• Is given training for work to be done, and
• Works for only one employer.
Simply put, if someone has set hours, is salaried or paid hourly and performs the job at your facility with tools, materials and instructions provided by you, they are an employee.
This should be enough information for you to properly determine whether you have independent contractors or employees, but if you are unsure, I always suggest you speak with your attorney or accountant.
We will be happy to assist you with HR issues and can help with the necessary steps to take before hiring an employee.
Becky Brownlee is a business consultant with The University of Georgia SBDC at Georgia Southern University and can be reached at firstname.lastname@example.org