Sunday, August 1, 2010

Your Independent Contractor Might be an Employee if…

In most cases it is fairly obvious to all concerned whether or not an employer-employee relationship exists. Many employers simply choose not to follow the rules. Virtually everyone has a buddy always going on about not having any employees/sending everyone a 1099 as though this policy proves he or she is way smarter than other business owners. Well, those friends may be singing a new tune before too long. Cracking down on such practices has become a national mandate:

Despite constituting a violation of both federal and state laws, worker misclassification has been widespread for decades due to virtually nonexistent enforcement of existing laws. So, the state legislators have decided we need… more laws! The difference is that the new state laws offer the potential for the misclassified worker to realize personal financial gain for blowing the whistle. Additionally, “commissions” – not courts - are being given the authority to follow up on complaints, conduct hearings, and dole out consequences.

Many of the new laws only apply to the construction and landscaping industries but the requirements to withhold and pay taxes for those who are in fact employees are applicable to all industries. Business owners who are compliant may seek to level the playing field by reporting their noncompliant competitors.

The following form assists the IRS with classifying a worker correctly. Look it over and turn a critical eye on your situation.

Some states have even more restrictive definitions than the IRS including the “rebuttable presumption of employee status.” My personal, unofficial rule of thumb: Assume anyone who is not listed in the phone book as a business is going to be your employee, and budget accordingly.

Here is how I proceed with budgeting for an employee:

  1. Determine my compensation budget for a new position. For example $20,000 for one 1800 hour per year position.
  2. Contact my insurance agent to find out what my worker’s compensation rate is for that classification. (Be sure to ask if there is a minimum annual premium.) Convert to decimal. For example 15% would be .15.
  3. Add 1 plus .12 (estimated FICA, FUTA, and SUTA – varies by state and unemployment experience rating) plus the decimal per my findings for number 2. For example 1+.12+.15=1.27
  4. Divide #1 by #4. This is the annual salary I can afford to offer. For example. $20,000/1.27=$15,750 or $8.75/hour. (Can’t be below minimum wage: $7.25 per hour for DE/MD/PA/NJ/VA at 6/30/2010)
I don’t offer someone $20,000 per year and then claim worker’s comp and matching taxes will bust my budget. It is my responsibility to budget for all the costs of employment. If you offer other benefits you will need to tweak this formula. I strongly recommend providing employees with a total compensation statement along with their W-2 statement each year to let them know the total company outlay resulting from his or her employment.

Even if someone meets the “phone book test” an employer/employee relationship may still exist or develop based on the specific nature of the dealings. The guidance on this topic is voluminous. Each situation must be evaluated individually. A prospective contractor will need to consult with his or her CPA, attorney, and insurance agent to discuss whether a worker may appropriately be classified as an independent and, if yes, the current, related, supporting documentation requirements.

Sometimes the forms and deadlines are more of a payroll deterrent than the expense. Employers often retain a CPA or payroll service to handle this. Fees may be as low as $100 per month. Another alternative is contracting workers through a staffing service. Staffing services employ workers and pay all required taxes and insurance then bill their customers for those expenses plus enough to cover overhead and profit. An business owner may pay the staffing service $13 for every $8 the employee is paid but this may be the best option, especially if subject to a high minimum annual worker’s comp premium and/or a worker is only needed for limited hours of work.

Bottom line: If you know a worker should be an employee then put him or her on payroll. You may be ok with circumnavigating the rules but it is never a safe bet that your workers will remain complicit both during and after the period in which they are depending on you for a living.


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