Whether a worker is called an employee or independent contractor by a business owner or manager is irrelevant to the employer-employee relationship. Employees are not permitted to waive their rights and employers are not allowed to circumvent the law by misclassifying an employee as independent contractor. When an employer-employee relationship exists, whether or not the parties recognize it as an employment relationship, the employer is responsible for:

• withholding and paying the employee portions of medicare and social security taxes,
• paying the employer portions of medicare and social security taxes,
• withholding the employee’s income taxes according to his/her W-4, and for paying them to the IRS on his/her behalf.

In general someone hired to perform a service is considered an employee if the employer has the “right to control what will be done, and how it will be done,” whereas independent contractors are obligated to the hiring company only for the outcome of the work, not for the method or means, nor for an accounting of his time; furthermore, employees are typically paid hourly or by salary for as long as the job requires, whereas independent contractors are usually paid an agreed-upon fee for the job as a whole, whether he completes it early or late. Your relationship with an independent contractor should be similar to those between your business and its clients, and your business and its vendors. Exceptions to these definitions, pertaining mostly to delivery drivers and insurance agents, can be complicated. If you are unsure as to how someone should be classified, you can request a determination of worker status from the IRS via Form SS-8.

Employers are often motivated to misclassify employees as independent contractors so they can save money on taxes and benefits – sometimes intentionally, sometimes because they don’t know otherwise, and sometimes because they believe that common practice allows it. This cost-saving strategy is flawed however, for the following reasons:

1. A disgruntled worker needs only to file a complaint with the Department of Labor to initiate an investigation into the company’s employment practices, resulting in penalties such as fines, the back-payment of all employer and employee taxes (without the ability to recover them from the employee), and any penalties for other infractions found during the investigation.
2. A worker who’s not savvy enough to negotiate a contract that compensates him for the employer taxes he has to pay, the benefits he would customarily receive as a full-time employee, and the additional time and costs associated with administering his “business” may not be a top-performer. The saying “You get what you pay for” comes to mind.
3. The costs associated with an investigation and process losses due to poor hiring decisions could exceed the value of any savings. Penalties and legal fees are apparent costs. Though uncomfortable and inconvenient, unbudgeted tax payments might be considered deferred costs, rather than additional costs because they should have been paid to begin with. Process losses occur when a low-cost, low-performing employee requires more training and supervision, and produces lower quality work than a more qualified employee who is paid a fair wage; they also occur when an investigation requires your cooperation, time and resources, and interrupts the normal conduct of business.

Regulatory agencies accept neither ignorance nor “because I was told to” as excuses. If you are a business owner or hiring manager, or work in human resources, accounting or payroll, IRS Publications 15 and 15a are the most important documents you need to read and understand in regards to basic employer responsibilities. Individuals can be held personally liable for mishandling anything they are responsible for, whether they were aware of the regulation or not; for whichever areas of employee processing you are responsible for, your job includes understanding the regulatory environment (FMLA, FLSA, DOL, etc.) raising issues with your superior(s) when something questionable crosses your desk, and protecting yourself from liability associated with non-compliance. Publications 15 and 15a, and Form SS-8 can be downloaded from http://www.irs.gov.

Senior consultant for http://pythagorian.net, Lisa Chelton provides readers with strategic planning tools, practical guidance for solving problems within organizational systems, and advice on gaining the support necessary to successfully implement change initiatives. If you have a specific question about your workplace, or would like to suggest a business to be profiled, please submit your comment through the contact form on our website.

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