Furthermore, a rose by any other name . . .

. . . may also bring a visit from the tax man (or woman).  Or the labor board.  Or a process server.

My previous “Rose By Any Other Name” posts have been about (a) misnamed/unnamed insureds and (b) contracts (verbal vs. written).  This post is about independent contractors who are really employees (at least, as far as the federal and state tax authorities are concerned), and other “thorny” employee classification issues.

At this time of rising State and Federal deficits, there seems to be an increased scrutiny of how small and medium sized businesses are classifying their workers.  In addition, attorneys who represent workers before the Labor Board seem to be experiencing an uptick in business, commensurate with rising unemployment.  This is strictly based upon anecdotal evidence (I’m receiving more calls from business owners on the receiving end of employee pay and benefit claims), but my suspicion is that such claims, as well as tax enforcement proceedings, are on the rise and will continue along that trend for some time to come. 

Proper classification of workers as independent contractors or employees (and if employees, as temporary, part-time or full-time and as exempt or non-exempt) can mean the difference between financial survival or failure, particularly for a small business, and small business owners, who do not have their own HR staff, are often the least equipped to make these determinations.  Failure to properly classify employees can leave a small business vulnerable to claims for legally mandated employee benefits such as workers’ compensation and unemployment benefits, for discretionary benefits such as health insurance and paid time off, and for back overtime pay.  Properly classifying employees is particularly difficult for small businesses with fluctuating staffing needs, since it is easy for a busy small business owner to forget to reclassify a temporary employee who becomes permanent, or a part-time employee who becomes full-time.   

The solution?  Well, my instinct as a lawyer is this – put it in writing, and keep it in writing.  Even temporary workers could be given something in writing that makes it clear that their status is temporary, with an approximate time limit.  Then calendar the end of that time limit, as a reminder to revisit the issue of how that worker should continue to be classified.  And even small businesses should have a written personnel policy to point to when your employee classifications (or other employment practices) are questioned.       

More dangerous than a misclassification of an employee is the improper classification of a worker as an independent contractor.  Such a misclassification leaves the employer vulnerable to back payroll taxes and penalties as well, which can be substantial enough to put you out of business.  And, whether a worker should be classified as an independent contractor or as an employee can be a particularly tricky determination for a small business owner to make, since the criteria for independent contractor status used by the IRS, the federal Department of Labor and state labor departments don’t all impose exactly the same standards. and are not “exact” but, rather, are open to some interpretation.  Even large companies, such as Microsoft and Federal Express, have been the subject of expensive enforcement actions alleging misclassification of workers.  The new targets for such actions appear to be small businesses, and I’m sure that has alot to do with the fact that they are the most likely to be mistakenly misclassifying their staff.    

The solution?  Again, my instinct is to put it in writing.  As far as I am concerned, a written contract is absolutely essential.  Even with a written contract, however, treating the independent contractor as an employee may indeed make the contractor an employee, whether that’s what you intended or not.  For an explanation of how the IRS analyzes these issues, see IRS Publication 15A.   

Finally, years ago one of my community association clients learned the hard way that even with no employees it still needed workers compensation insurance.  That is because California’s Labor Code provides that one who hires a worker to perform work requiring a license is that worker’s employer if it turns out that the worker doesn’t have the required license.  (It may shock you to hear that sometimes unlicensed contractors lie about their unlicensed status and either provide a fraudulent contractor’s license number or “borrow” another contractor’s license number.)  The association hired an unlicensed contractor, one of the contractor’s employees was injured, and the association was on the hook, with no workers compensation insurance and with a workers compensation exclusion in its commercial general liability insurance policy.  To get a better feel for how California’s Workers’ Compensation Appeals Board analyzes the issue of employment status, take a look here

The solution to this problem?  Legal liability risk management, plain and simple.  A good insurance broker and an attorney to prepare the association’s own contracts, requiring contractors to maintain appropriate licenses and insurance coverage, would have been a big help.

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3 CommentsLeave a comment

  1. Documenting in writing that an employee is considered a 1099 may fly in states that don’t have their own employment law, however in the State of California, such a “contract” won’t work because the Labor Commissioner looks at the following items.
    (1) Who provides the specification and direction of the work to be completed;(2) who provides the equipment; (3) Who has the ultimate say as to how and in what capacity the work is performed. (e.g. hours, location, etc.)

    If you are an employer then your best bet is to attend any of the various and FREE seminars provided by the EDD regarding the correct classification of employees. Misclassification can and will result in fines and penalties.

    • I don’t disagree with you. In fact, as I pointed out in my post, “[e]ven with a written contract . . . treating the independent contractor as an employee may indeed make the contractor an employee, whether that’s what you intended or not.” A written agreement defining the relationship between the parties is only one factor which the IRS, the Franchise Tax Board and/or the Employment Development Department would consider, but in my opinion is an important piece of the puzzle which is often overlooked.

  2. […] liability issues which should be addressed and managed with appropriate written agreements.  See here for a related post on some of these issues.  As far as I am concerned, there is no good reason not […]


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