Thursday, February 18, 2010

Employee or Independent Contractor? How much are you willing to bet?

A significant number of employers cut corners by classifying their employees as "independent contractors." These employers are also hoping to avoid considerable employment taxes which are due to Federal, state and even local departments of revenue. The New York Times reported yesterday that Federal and state officials are beginning to pursue aggressively those employers who misclassify employees as independent contractors, in an effort to address their deficits.

Professional firms are among the most notorious who do this. I know many law firms who treat their associates as independent contractors, issuing 1099's at year's end, and expecting their associates to file business tax returns in those municipalities where such taxes are required. In addition, many other service companies --- cleaning, contracting, delivery --- use the "independent contractor" approach to dodge paying employment taxes.

While case law varies from state to state, much of the legal analysis comes from a well-established United States Supreme Court decision
United States v. Silk, 331 U.S. 704 (1947). In that case, the Court outlined several criteria which are still followed to this date in determining whether an employee is an employee or a genuine independent contractor:
  1. The degree of the employer's control, that is, to what extent does the employer dictate how, when and where the job is performed?
  2. The alleged independent contractor’s investment in facilities and tools. Does the employer supply the tools, equipment and supplies or does the independent contractor?
  3. The independent contractor’s exposure to “profit and loss.” Is the alleged independent contractor dealing with costs versus sales or is their compensation thinly disguised piece work, hourly work, or salaried?
  4. The permanency of the relationship between the parties. Is this a one shot deal? Have the two been working together for years? Is the employer "assigning" jobs to the independent contractor like a referral agency, or is the employee intrinsically part of the employer's operations?
  5. The skill involved.
Courts have also considered collateral issues such as the independent contractor’s ability to work for others and the independent contractor’s ability to “determine their own direction in the marketplace” in assessing whether an individual is an employee or an independent contractor.

Remember that there can be individual liability on the part of corporate officers for unpaid employment taxes, and no corporate structure will adequately protect individuals from such liability. In addition, many states provide for criminal liability on the part of non-paying employers, and I know of more than one corporate officer with reporting probation while a past balance of unemployment compensation tax is paid off.

So, you may call those employees of yours independent contractors, but how much do you really want to bet?


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