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I want to bring on a new worker, should they be an employee or an independent contractor?

So, the question that’s posed by a company is, “I want to bring on a new worker, should they be an employee or an independent contractor?” Or perhaps the company has already brought someone on as a contractor, and now they’re worried they’ve misclassified them. What’s the difference between an employee and a contractor, and what are the consequences for getting it wrong?

It’s incredibly tempting to classify a worker as an independent contractor, rather than as an employee. You don’t have to pay overtime or even the minimum wage. You don’t have to provide unemployment or workers’ compensation benefits or any other employment benefits for that matter. And you don’t have to pay what would be the employer’s share of the worker’s Social Security and Medicare taxes.

But these advantages come at a price. And when a company tries to gain the advantage without paying that price, that’s when the government cracks down, auditing the company’s classification of its workers.

The penalty for misclassifying someone as an independent contractor, when they would be more properly classified as an employee, includes the assessment of back taxes and hefty fines, plus interest—regardless of whether the misclassification was intentional or not.

So how should you classify your workers? It’s not an exact science. However, the IRS publishes a list of factors to help business owners determine the proper classification based on the amount of control the business owner exerts over the would-be contractor. Keep in mind that while a company can give the contractor specific assignments and set production goals and the like, the company cannot directly control how the contractor performs their work. This is the price I was referring to earlier.

In order to gain the financial advantage of having an independent contractor, your company pays the price of giving up significant control. For example, you could engage someone to provide bookkeeping services for you. You can expect the books to be balanced, payroll to be met, and taxes to be paid on time. But you can’t control the hours the contractor works, the software used, or any other factor related to how they get the job done.

Here’s a non-exclusive list of questions for you to consider. You can think of a scale with a bucket on either side. As you go through the factors, you drop a pebble into either the contractor bucket or the employee bucket. And at the end you see to which side the scale tips. However, having said that, there may be unique circumstances where one factor is so egregiously met, that it could, in theory, outweigh all the rest. It’s really a case-by-case analysis. But just to give you an idea, here are those factors.

Question: Is the worker operating under the worker’s individual name rather than as a legal entity, like an LLC? If they’re working under their individual name, it’s more likely that they’re an employee than a contractor—not necessarily, but more likely.

Does the company dictate where the worker performs their work? If yes, they’re likely an employee.

Does the company dictate when the worker has to work? If yes, likely an employee.

Does the company instruct the worker on how the work is to be done? You know the answer to that already. If so, then they’re likely an employee.

Does the worker use the company’s equipment and supplies, or is the worker using the company staff? If yes, then the worker is more likely an employee.

Does the company dictate the worker’s rate of pay? Yes? Then likely an employee. If the worker sets their own fee schedule, that’s when we’re looking at more of an independent contractor situation.

Is the type of work the worker does for the company the same type of work the company’s employees do? This can be a red flag. And if that’s true, it’s likely an employee.

Does the company restrict the worker to work only for the company’s clinic? If that’s true, they’re more likely an employee.

Does the company reimburse the worker for any expenses, or pay liability insurance, or provide any benefits for training? If those things are true, likely an employee.

And here’s the last one. Can the company terminate the contract early, without paying a penalty, or without having to pay a daily minimum for cancellation? If that’s true, it sounds like an at-will employee relationship.

So as a matter of example, Minnesota veterinarians often use what’s known as relief vets, who come into their clinics on a short-term basis to see the vet’s patients while the vet is away on vacation. The classification of relief vets came under scrutiny a few years ago, and there were particular circumstances that were under review.

The Unemployment Law Judge reversed the decision of the auditor, finding that even though the relief vet received an hourly rate of pay and used the veterinarian’s staff, materials and tools—all things that were indicative of employee relationship—the relief vet was an independent contractor because the veterinarian did not leave instructions for the relief vet, the relief vet was allowed to practice veterinary medicine in the clinic according to her own professional judgment, the relief vet was not subject to performance reviews, the relief vet had the right to charge a cancellation fee if the veterinarian decided not to go on vacation after all, and the relief vet secured her own liability insurance.

Two of the easiest things for business owners to do to increase the chance of having their independent contractors be deemed properly classified, is to engage an attorney to draft an independent contractor agreement that’s specifically tailored to their unique business and to engage contractors who operate as legal entities, like LLCs. So, for example, you would engage John Smith Services, LLC, rather than John Smith.

Again, no one factor is necessarily determinative. Even having a written independent contractor agreement won’t save you if the day-to-day reality is that you’re treating the contractors as employees. But with the more power, responsibility and decision-making control you can put in the worker’s hands, the more likely it is your audit will go in your favor. If you have other questions or would like to engage Sjoberg & Tebelius, P.A. to draft or review your independent contractor agreements, give us a call at (651) 738-3433.