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Is Your Independent Contractor Misclassified?

Working with independent contractors is nothing new. In fact, cities throughout the region including Austin, Houston, Plano and Oklahoma City are considered some of the top places to find freelancers (who often classify themselves as independent contractors for IRS purposes). What is new, though, is the amount of scrutiny the federal government is dishing to employers that misclassify independent contractors.

Last month, for instance, the U.S. Department of Labor (DOL) obtained a consent judgement ordering a Kentucky corporation to pay nearly 200 employees a total of more than $1 million in back wages (including overtime) and liquidated damages. In the past year alone, the DOL signed special agreements to protect misclassified workers in Rhode Island, Wisconsin, Florida and Alabama. What’s the big deal?

“The misclassification of employees as independent contractors cheats workers of wages and benefits to which they would otherwise be entitled to under the law,” explains acting Secretary of Labor Seth D. Harris. “It also leads to unfair competition because businesses that play by the rules operate at a disadvantage to those that don’t.”

But here’s the rub: You may be misclassifying your independent contractors and not even know it. Or, perhaps the roles and responsibilities of specific independent contractors have changed or evolved over time. The IRS offers a 20-point independent contractor test that can help you determine whether or not an independent contractor is classified correctly. The full overview can be accessed here.  Following are the three main factors to know:

  • Behavior control: You cannot control when, where and how an independent contractor performs the services they’ve been hired to perform. A gigantic red flag for the IRS is whether a contractor is required to work at a particular location or office, on special equipment provided by the employer and/or with specific training provided by the employer.
  • Financial control: Independent contractors aren’t reimbursed for expenses as often as employees are. Also, contractors will usually provide invoices and charge flat or project fees, as opposed to expecting hourly, weekly or monthly wages. Contractors also incur their own expenses and cost of doing business, including marketing and advertising expenses. The IRS may look at each of these factors.
  • Relationship: Written contracts, letters of agreement and invoices all give clues as to how “permanent” and “controlling” the relationship may be. Certainly promising an independent contractor employee-type benefits such as insurance or vacation pay is an indication the individual is misclassified. A more subtle sign would be the lack of a contract that terminates (or can be renewed) on a specific date, indicating you intend to work with the individual indefinitely, much like an employee.

The Society for Human Resource Management recently published a helpful article outlining these and more tips, including ways to defend independent contractor classifications if they come into question (it’s actually been done…successfully). Keep in mind, too, that staffing firms can offer an alternative to the seemingly black-and-white options of using independent contractors versus hiring employees.

With these factors in mind, do you think it’s time to review your own working relationships with outside contractors? What grey areas have you found confusing in the past?


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