Are your Workers Employees or Independent Contractors? Making the Wrong Decision can be Damaging by Cherry Laufenberg, CPA
Despite the Department of Labor’s recent retraction of the prior administration’s narrow interpretation of the Fair Labor Standards Act (FLSA), businesses must remain vigilant in upholding the underlying law that requires proper classification of workers as either employees or independent contractors. Failure to do so can put businesses at risk of legal exposure, severe penalties on the state and federal levels, and required payments of back wages and taxes.
Under the provisions of the FLSA, employers must provide full-time employees with a minimum wage and specific benefits, including worker’s compensation and unemployment insurance, while also bearing the responsibility of paying the employees’ federal and state employment taxes. Individual states, such as Florida, New York and New Jersey, have similar laws in place to protect workers and ensure that employers pay their fair share in taxes.
In response to a surge in the number of employers that misclassified workers as independent contractors, either erroneously or intentionally, the DOL’s Wage and Hour Division in 2015 directed businesses to expand their assessment of employee relationships and presume that most of their workers are in fact “employees” under the FLSA. With the Trump administration’s intent to dismantle this broad definition, combined with the gig economy’s blurring lines between employees and independent contractors, businesses must take the time to understand the laws on the state and federal levels and properly assess their relationships with workers.
Employee or Independent Contractor
In the broadest terms, employee classification comes down to the relationship between the employer and the worker and the nature and level of control that the employer has over the directing the worker’s job and financial earnings. The more control the employer has, the more likely the worker is an employee. To help businesses make this determination, the IRS advises that employers ask themselves following questions:
1. Is the company responsible for directing what the worker does and how he or she does it?
2. Does the company provide the worker with tools and other supplies required to get the job done?
3. Are the services provided by the worker considered to be an integral part of the company’s business?
4. Does the business control how the worker is paid, including reimbursements for expenses the worker incurs while performing his or her job?
5. Does the business provide the worker with employee-type benefits, such as paid vacation days, insurance and/or access to a retirement savings plan?
6. Are there written contracts or employee type benefits that the company provides to the worker (i.e. pension plan, insurance, vacation pay, etc.)?
7. Is the relationship between the company and the worker considered permanent, judging by the standards of businesses in similar industries?
When the answers to all of these questions is “yes”, the worker is an employee, for whom the business must withhold income taxes and pay Social Security, Medicare taxes and unemployment tax on wages it pays to the employee. Independent contractors are responsible for paying their tax liabilities individually, including all federal and state payroll taxes for themselves as both employer and employee. Additionally, independent contractors, who may enjoy the benefits of flexible work arrangements, should note that they will not be covered by the safety net protections provided by employer, including worker’s compensation and unemployment insurance.
Under most circumstances, however, not all answers to these questions will be in the affirmative and neither will the answers be the same from one situation to another. This is especially true in today’s sharing economy, in which freelance, on-demand workers are becoming more and more common. While one factor does not weigh heavier than the others, businesses should consider all elements when making an employee or independent contractor determination, including the standards set forth by their states and those used by other businesses in similar industries.
For example, Florida recently passed a law that requires ride-sharing companies, such as Uber, to treat their drivers as independent contractors, and not employees, as long as the companies do not specify the drivers’ hours or restrict the drivers’ involvement in other businesses. In addition, worker classification has long been a challenge in the real estate and construction industries, where it is common for developers to misclassify sub-contractors in business for themselves as independent contractors. In reality, subcontractors should often be treated as employees, for whom developers must bear of the burden of paying exceedingly high worker’s compensation insurance, especially when their work is an integral part of the developer’s business and the developer has behavioral and financial control over the subs’ responsibilities and payments.
When in doubt, businesses may consider erring on the side of caution and treating a worker as an employee to avoid any potential legal exposure in the future. No matter what decision they make, businesses should document their rationale for how they classify each and every worker.
About the Author: Cherry Laufenberg, CPA, is an associate director of Tax Services with Berkowitz Pollack Brant, where she works with corporations, pass-through entities, trusts and foreign entities. She can be reached at the CPA firm’s Ft. Lauderdale, Fla., office at (954) 712-7000 or via email at email@example.com.