Democrats in the U.S. House are seeking to pass the Protecting the Right to Organize Act, otherwise known as the PRO Act, a pro-labor bill that would help independent contractors — “gig” workers — unionize. Though Senate passage seems unlikely, the action is another sign of nationwide movement that may create significant changes for how companies classify this kind of worker.
Many small-business owners, like myself, prefer to use independent contractors where we can. It saves us on employer payroll taxes and payment of certain employee benefits such as health insurance, retirement, and time off.
We can also avoid federal and state tax and regulatory paperwork required for employees. Many of our independent contractors enjoy their independence and the ability to pick and choose their jobs, work hours, and clients.
However, many gig workers wants the benefits and protections that employees receive at companies. President Joe Biden supports such protections. California had already imposed tough new rules.
But for now, most of the federal and state guidelines for classifying employees and independent contractors remain in effect. Even so, employers that don’t comply could find themselves in a difficult situation. The problem, some experts say, is that many business owners don’t fully understand the rules.
“Most business owners want to hire a contractor in order to avoid what they see as the hassle of hiring a direct employee,” says Sarah Holmes, an Ardmore-based attorney that specializes in small business.
“Many business owners hiring for the first time incorrectly think that an employee is a full-time, regular staff member on a salary. They don’t realize that even someone that occasionally works for the employer may need to be a classified as an employee.”
Unfortunately, not understanding or fully complying with these rules can be very costly, particularly for a small business according to Steven J. Fromm, a business attorney based in Fort Washington.
“The drawbacks could be devastating if a tax audit occurs and it turns out that these workers are truly employees,” he says. “Payroll taxes at the federal, state, and local level would be owed with interest and penalties added on. The amounts owed could be so large that the employer could not survive these tax, interest, and penalty assessments.”
Pennsylvania and New Jersey (which recently updated its rules) each has its own worker-classification guidelines which are generally consistent with rules published by the Internal Revenue Service. All take into consideration a few common factors.
One factor has to do with the relationship a company has with a worker. Such a relationship would take into account whether the worker receives employee-type benefits like insurance or paid time off, the permanency of the relationship and the extent to which services performed by the worker are a key aspect of the company’s regular business.
“An independent contractor is not interchangeable with an employee and the contractor is not necessarily a true contractor just because the employer says so,” says Holmes.
“If this is a worker the employer needs to train or tell who, when, and where to do a job, that should raise red flags that it’s probably not a proper contractor. Also, if it is someone the employer wants to work indefinitely for the company, then that person is also probably not a contractor.”
Both state and federal rules also look at the level of control a company exerts over its workers. For example, if a business controls what work is accomplished and directs how it is done, the IRS or a state Department of Labor may infer that control exists. Or if a business directs or controls financial and certain relevant aspects of a worker’s job, then financial control may also be suspected.
“An employer should not be exercising any control over an independent contractor,” says Holmes. “There should be no training, no equipment or supplies provided, no designation as to how the contractor should dress or behave. A proper contractor is really someone already running their own business.”
All of these considerations need to be specifically included in a mutual contract between a company and its outside contractors. The agreement should specifically state that the contractor is independent, self-employed and is responsible for his or her own tax reporting and compliance as well as insurance and other costs.
It should clearly state that although the company can direct the work performed, it cannot tell the contractor how to do it. The agreement should document the specific tasks that will be performed by a contractor as well as payment terms. It should also be for a finite period of time. Good examples of an independent contractor’s agreement can be found on online legal sites such as Legal Zoom and Rocket Lawyer.
“Business owners can be quite cavalier with these classification issues,” says Fromm. “They need to understand that the facts must support independent contractor status. Otherwise, they may be putting their whole business well-being at risk.”
Gene Marks is a certified public accountant and the owner of the Marks Group, a technology and financial management consulting firm in Bala Cynwyd.