I avoid all that HR stuff. I don’t have employees. I only use Independent Contractors.
How many times have I heard that from an entrepreneur? Well I’ll tell you – more times than I can count. And each time, my heart shrinks a little bit, because it makes me scared for them.
Because, you see – the chance that you can have a company without any employees, only contractors, and that those contractors actually qualify as independent contractors – well, it’s a very tiny chance that’s all true.
So let’s talk about the reasons that’s the case.
First, for someone to be an independent contractor, they have to meet the qualification set out by a number of agencies/regulatory bodies – and those qualifications are in place to ensure they are acting as an independent business. Because essentially, that’s what an independent contractor is – a separate business.
Now, at the federal level, the Department of Labor has an opinion (and a set of guidelines), and the IRS has an opinion (and another set of guidelines). And then there are various states, and their opinions and guidelines. And while your contractor might meet the guidelines of one, or two, they may not meet the guidelines of the third. And if they miss the guidelines of any one of them, then they won’t qualify as an independent contractor.
Let’s take a closer look at the state laws. Some use the Common Law test – which is a set of IRS guidelines – that measures how much control the employer has over the contractor.
“…the feds might even require you to pay both the employer AND employee part of things like social security, unemployment and income taxes – that’s right, I said INCOME taxes.“
Other states use some version of an ABC test, or even something else. As an example – let’s take California. We have something called the Borello test for specific occupations. But for most jobs we adhere to an ABC test – the A part of the test is focused on control. Is the person free from control and/or direction. That means you don’t manage them, you don’t tell them how to do something – they are simply providing an end product for you – like a separate business would.
I’ll get back to the B in a second. Let’s move on to the C part. Is the person engaged in an independently established trade, occupation or business that’s different from yours? Basically that means, are they a separate business entity – and are they providing a product or service that is completely separate from what your business provides?
And that brings be full circle back to the B qualification. I saved it for last because it’s the challenging part of the ABC test. With few exceptions, if the contractor is performing work that’s critical to your business (for instance, you’re a copywriting service, and you take on a contractor to do copywriting), then they can’t qualify as an independent contractor. That’s the B in the ABC rule.
Now, as you might guess, that knocks out a large block on independent contractors; because even if they do qualify as a contractor under parts A and C – it won’t count because they have to meet all three qualifications, A, B and C.
OK – so the next thing I hear all the time is – well we both agree that he’s an independent contractor. I want it and he wants it. And he has signed an agreement stating that he’s an independent contractor. So we’re all set – right?
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Well, not quite – because you see you can’t decide, and he can’t decide -neither of you are the decider. The agency representative is the decider. And this isn’t something that can be ‘agreed’ away by both parties.
So then I hear – well OK. If I do get it wrong, what’s the penalty. Well, at the time of this episode, the California Labor Code (section 226.8 by the way) provides for civil penalties of between $5,000 and $25,000 for each violation. So even if you have 3 misclassified people – well, you do the math.
And in addition – the individual can decide to file a suit against you. Because they suffered losses connected to not being considered an employee. No overtime, no minimum wage, no workers comp, no unemployment insurance and on and on.
Oh, and an extra added bonus – there are also tax penalties to think about, because you didn’t pay any payroll taxes on that person. And in fact, the feds might even require you to pay both the employer AND employee part of things like social security, unemployment and income taxes – that’s right, I said INCOME taxes.
So, all in all – it’s a really good idea to think carefully (and maybe even consult with an HR expert or your labor attorney) before assuming that person is an independent contractor.
And remember – while they may really want to be labeled as an independent contractor – you’ve got to stand firm. Because all the down side is – well it’s all on your side.