Think You’re an Employee?…Think Again

When you’re working for a company or employer of some kind, it would only make sense to think of yourself as an employee wouldn’t it? Ah, if only it was that simple. However, various positions of employment are considered “Independent Contractors” for various reasons under the law and the differences between the two titles are vast.

It is vital to get informed and know your rights as an Employee or Independent Contractor to ensure your legal rights are protected and you receive the benefits you deserve. Here’s a section of my book “The Employee Rights Handbook” that deals with just that.

Employee Versus Independent Contractor Status

There is a growing effort by federal and state agencies to investigate and audit companies who misclassify employees and annually cheat the government out of hundreds of millions of dollars of unpaid taxes and wages. Independent contractors are less costly than salaried workers because an employer is not responsible to pay for or withhold their payroll taxes, fund the employer-matching portion of the Federal Insurance Contributions Act (FICA), or provide benefits. Workers classified as employees have more rights under federal and state labor laws, such as being protected against discrimination, minimum wage and overtime pay abuses, workers’ compensation coverage, actions from labor organizations seeking to enforce safety, and pension and employee benefit considerations, among other considerations. As an example, employers are generally liable for the negligent acts of their employers but not for their independent contractor workers.

A widely reported case in this area involved a ruling against Microsoft. A group of freelance programmers who were paid higher hourly rates than comparable employees commenced a lawsuit demanding various savings and stock-option benefits. After the U.S. Court of Appeals for the 9th Circuit ruled that Microsoft exercised sufficient control over these workers, they were deemed to be employees and entitled to such benefits.

The IRS generally opposes independent status because companies who retain independents don’t have to withhold income or employment taxes. Since a contractor can manipulate earnings by claiming all business-related expenses on Schedule C (where expenses offset gross business income), the IRS believes that many dollars of compensation go unreported. Additionally, if you are an independent contractor who is injured while working, you are not bound to collecting workers’ compensation damages for your injuries. This is advantageous, since the awards are typically larger for claimants who commence private lawsuits for injuries than for those who receive workers’ compensation benefits.

As an independent contractor, however, you are not permitted to file for unemployment benefits after a job has ended or you are terminated unless it is determined at the unemployment hearing that you are legally an employee. You probably cannot avail yourself of employer-provided disability and health insurance plans and may have to establish your own retirement and pension plans. Since you will receive an IRS Form 1099 and not a W-2 form with deductions withheld, you are responsible to pay all applicable Social Security, unemployment insurance, state and local income taxes, and workers’ compensation insurance benefits for any people you employ. Under the laws of many states, you will probably have a more difficult time asserting discrimination claims. Furthermore, you cannot assert claims for overtime, since wage and hour laws apply only to employees.

No precise legal definition of an independent contractor exists, and each state has its own laws to determine whether an individual is an employee or an independent contractor. When the courts attempt to determine the difference, they analyze the facts of each particular case.

Significant factors courts look for when making this distinction are:

1. The company’s right of control over the worker.

2. Whether the individual works exclusively for the company or is permitted to work for others at the same time.

3. Whether the parties have a written agreement that defines the status of the worker and states she is not considered an employee for the purposes of the Federal Contributions Act and the Federal Unemployment Tax Act and that the individual must pay all self-employment and federal income tax.

4. Whether the individual controls her own work schedule and the number of working hours.

5. Whether the individual operates from her own place of business (or pays rent if an office is provided) and supplies her own stationery and business cards not at the company’s expense.

Typically, employees undertake to achieve an agreed result and to accept an employer’s directions as to the manner in which the result is accomplished, while independent contractors agree to achieve a certain result but are not subject to the orders of the employer as to the means that were used. In each case, the court looks at the specific facts in making its determination. For instructive purposes, the company’s

right of control is best explained by the use of examples.

Courts have found workers to be employees if companies:

  • Have the right to supervise details of the operation
  • Require salespeople to collect accounts on its behalf
  • Provide workers with an office, company equipment, company car, and/or reimbursement for some or all expenses
  • Require workers to call on particular customers
  • Deduct income and FICA taxes from their wages or salary
  • Provide workers with insurance and workers’ compensation benefits
  • Restrict their ability to work for other companies or jobs and require full-time efforts

This list is not meant to be all-inclusive, but rather to help you determine what classification you fall under. Since the law is quite unsettled, the IRS follows a summary of rules used to determine proper status. According to the IRS, an employer-employee relationship for tax purposes exists when the person for whom the services are performed has the right to control and direct the individual who performs the services, not only as to the result to be accomplished by the work but also as to the details and means by which the result is accomplished. In this connection it is not necessary that the employer actually direct or control the manner in which services are performed; it is sufficient if the firm had the right to do so. The designation or description of the relationship of the parties in a written agreement other than that of an employer and employee is immaterial if such a relationship exists, and the IRS will disregard other designations (such as being called a partner, agent, consultant, or independent contractor) in the agreement.

STRATEGY: The odds of finding employee status become lower when you form a corporation and receive compensation from your corporation. The IRS is also impressed when you or your corporation works for several companies and not just one.

When an initial determination is made by the IRS finding employee status, costly damages, penalties, and interest can ensue to you and the company hiring you. In misclassification cases the company will be required to pay all back withholding taxes plus interest, even if the misclassified independent contractors have already paid their taxes. The IRS and other agencies might also levy huge fines and press criminal charges against company officials.

Independent contractors are responsible to provide their own workers’ compensation insurance under most state worker compensation laws. However, a company is obligated to provide workers’ compensation insurance on the independent contractor’s behalf (and employees of a subcontractor) when the independent contractor fails to provide his own.

Speak to a competent lawyer or accountant immediately upon receiving an initial IRS or state taxing authority notice of determination or request for facts. Competent tax advice and guidance are crucial in this area.

If you are not a statutory or common law employee (which includes leased employees, part-time workers, and temporaries), you are legally considered to be an independent contractor. This is so even if you call yourself a consultant or subcontractor. As an independent contractor, it is crucial to discuss all the terms and conditions of your working relationship with a company or individual. This must be done before commencing work, no matter what your trade or profession. All key terms of the relationship, including the services to be rendered, payment, stages of payment, whether expenses are to be reimbursed (and to what extent), and the length (also known as the term) of the arrangement, should be understood and agreed upon to reduce misunderstandings.

For a full depth analysis on this topic and many more, visit http://legalstrategiespublishing.com/ to purchase “The Employee Rights Handbook” today!

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