OK HR Blog

One of the most common questions employers ask is whether to classify a new (or current) position in their organization as a “contractor” or an “employee”. To most employers, their definition of an independent contractor involves someone who works for their organization on a project or temporary basis. Little do they know that the IRS has a much narrower definition of the term “contractor”.

The Internal Revenue Service very simply defines an independent contractor as someone who is self-employed. Conversely, an individual is not an independent contractor if they “perform services that can be controlled by an employer (what will be done and how it will be done)”.

To assist in determining contractor status, ask yourself the following questions about the individual:

1. Do you control the method by which the work is performed or is the individual considered an expert who determines which work methods are most appropriate?
2. Do you furnish the individual with a workspace, computer, or any other company equipment or do they supply their own equipment?
3. Will the individual be performing tasks for your organization that are similar to those that your employees perform?
4. Does the individual perform work for your company exclusively or do they have other clients to whom they provide services?
5. Is the individual paid on a continual basis at fixed intervals (i.e. biweekly) or are they paid for the results once their project is completed?

Fifteen other factors are considered by the IRS in determining whether or not an individual is an independent contractor or an employee. It is important to note that not one single factor determines the status. Organizations should look at the position as a whole and take all twenty factors into consideration before making their decision. Just because an individual is working on a temporary basis does not mean they should be classified as an independent contractor. The main question companies should ask themselves is “Does the individual walk, talk, and act like an employee?”

Why is this important? It all comes down to liability.

On September 19, 2011, the Department of Labor issued a press release outlining a signed memorandum of understanding between the Department of Labor and the Internal Revenue Service. In short, the press release indicates that the two agencies are teaming up to improve efforts to end misclassification of employees. They hope to “level the playing field” and “ensure that employees receive the protections to which they are entitled under federal and state law.”  Needless to say, this issue is high on the radar and misbehaving employers will be targeted. This partnership could equate to steep penalties and fines to organizations who incorrectly classify workers as independent contractors.

Other potential exposures include:

• Unpaid payroll taxes – Companies do not submit payment for payroll taxes for workers who are not classified as employees. This causes great heartburn with the IRS and your state’s employment security commission.
• Benefits eligibility – Companies typically do not offer employee benefits to individuals who they classify as an independent contractor.  What happens when that worker sees employees performing the same duties as them having access to employer-sponsored health benefits?
• Unemployment – What happens when a former independent contractor files for unemployment because they believed they were an employee?
• Wage & Hour claims – If an individual believes they should have been classified as an employee – they may feel they are due overtime for hours worked over 40 in a workweek.
• Workers’ Compensation claims – What happens when an individual classified as an independent contractor becomes injured while performing work for your organization and wants to file a workers’ compensation claim?
• Countless other potential disputes.

The topic is not going anywhere. In fact, we will likely see an increased focus from governmental agencies on this issue as a means to boost revenue. Bottom line – never make assumptions or quick judgments when it comes to classifying workers. Always ask questions and conduct research using helpful websites like SHRM, the Department of Labor, and Internal Revenue Service. My personal rule-of-thumb is to always err on the side of caution. When in doubt, the individual is probably an employee.

Disclaimer: While we go to great lengths to ensure that the information contained in this blog is accurate and useful, it is not legal advice. If you feel that you need legal advice regarding a particular matter, please contact your organization’s legal counsel.

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Lindsey Nichols, SPHR is the Human Resources Manager at Nextep, an industry-leading Professional Employer Organization located in Norman. Nextep provides professional services for small to mid-sized companies including human resources consultation, payroll administration, benefits administration, and risk management. In her role at Nextep, she oversees the Human Resources and Risk Management functions that provide exceptional service and expertise to the organization’s clients. Lindsey was elected to serve a two-year term as the Secretary/Treasurer for the Oklahoma State Council for Human Resource Management (OKHR) in 2011. Connect with Lindsey on LinkedIn!