Independent contractor or employee? The question has entered the ring after late-night comedian John Oliver criticized World Wrestling Entertainment for not considering its star wrestlers employees.
He makes a compelling case on his show, Last Week Tonight, that WWE wrestlers should be considered employees who are entitled to benefits such as health insurance, paid time off, and retirement plans. Both classifications of workers are important to the economy, especially as an estimated 56.7 million Americans are choosing to freelance.
But oftentimes the lines between employees and independent contractors can blur. An employee could easily be misclassified as an independent contractor.
Employers can face steep fines and – in some cases - even prison time if they consider their workers independent contractors when they should be employees.
Now may be a good time to take a step back and determine whether the Hulk Hogans of your company should be re-classified.
Defining the Issue Between a Contractor and an Employee
Employers who use independent contractors can “control or direct only the result of the work and not what will be done and how it will be done,” according to the Internal Revenue Service’s broad definition of the matter.
“You are not an independent contractor if you perform services that can be controlled by an employer (what will be done and how it will be done). This applies even if you are given freedom of action. What matters is that the employer has the legal right to control the details of how the services are performed.”
To determine whether you’re right, you must examine the relationship between the worker and your business in three main categories:
- Behavioral Control:Does your business direct and control what work is done or how it is done through instructions or training?
- Financial Control:Does your business control the financial and business aspects of the worker’s job? Consider who paid for the equipment, such as a laptop, the worker uses; how much unreimbursed business expenses he or she may have; who is dictating the worker’s schedule; or how much the worker makes his or her services available to others in the market.
- Relationship of the Parties: Does your business have a written contract with the worker? Is their work a key aspect of your regular business? Will the worker be involved with your company for a long period of time?
While the IRS and the Department of Labor control federal laws on this matter, each state also has a unique set of rules on who is considered an employee.
Some Gray Areas When Classifying Workers
Because of that, there may be some gray areas in your line of business.
For example, a Georgia real estate agent facing a lawsuit (Mark Six Realty Assoc. v. Drake) argued that the company she worked for should handle litigation on her behalf. The company disagreed, arguing she was an independent contractor, not an employee, and therefore not entitled to in-house representation. The court ultimately sided with the real estate agent when the judge found out she was required to attend sales meetings at a set time and place and was asked to keep certain office hours. The company had control over her schedule -- answering a key question in the IRS’s guidelines.
In another lawsuit (Lopez et al. v. El Palmar Taxi, Inc.), the company for a taxi driver refused to pay damages related to injuries a passenger sustained in an accident. It argued it was not liable for the driver’s negligence because he was an independent contractor.
The judge sided with the company because the driver could work anywhere, anytime he wanted, and was also able to accept or decline trips or extra work the company asked of him.
Mistakes Could be Costly
Independent contractors who want the IRS to issue an opinion specific to their situation can file Form SS-8. The IRS will ask the employer for clarification or justification for their status -- oftentimes an arduous process for the company that could lead to fines if the IRS finds employees were misclassified.
Those who unintentionally misclassified employees as independent contractors can face steep consequences:
- A $50 fine for each W-2 that was not filed;
- Monetary penalties of 1.5 percent wages, 40 percent FICA taxes not withheld from the employee, and 100 percent of the employer’s FICA taxes;
- And a Failure to Pay Taxes fine of up to 25 percent of the unpaid tax liability.
The punishment is even more severe for intentional misconduct:
- A cash payment of 20 percent wages, 100 percent FICA taxes not withheld from the employee, and 100 percent of the employer’s FICA taxes;
- A $1,000 criminal fine for each misclassified worker;
- And, in some states, up to one year in prison.
Given the seriousness of these consequences and the IRS’s recommitted efforts to collecting employment taxes, it’s important to take a hard look at your workers’ classifications and determine whether changes should be made. If you have any questions, please contact us.
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