The Fine, Dangerous Line Between Employees and Contractors

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The cost of misclassifying employees as contractors

The cost of misclassifying employees as contractors

So, did you know that if you classify someone as a contractor, but your behavior toward that person says “employee,”  you can be held accountable not only for unemployment compensation but also back taxes, federal income tax, Social Security tax and Medicare tax that you should have paid for that employee (and starting in 2014 health care benefits)? Of course, you can’t take any of that out of the employee/contractor’s paycheck now. It’s too late. It comes out of your pocket.  So businesses should make sure they know exactly what constitutes a contractor before hiring one.

A recent spate of legal cases has illustrated what a big problem this is:

  • Home improvement giant Lowe’s was sued by a company that it used to install decks, fences and other items, for back wages, unemployment compensation and liquid and compensatory damages.
  • FedEx has been embroiled in a multi-state, years-long suit brought by drivers who said they were misclassified as contractors. Some states have decided in favor of FedEx. Others have decided in favor of the drivers, including a $27 million judgment against the company in California for misclassifying its drivers.
  • Even exotic dancers in several cities have sued for overtime and other compensation after being misclassified as contractors. In Atlanta, a group of former exotic dancers won $1.5 million from the Onyx Club for not receiving pay they earned as employees.

The thing employers forget is that classification as an employee or contractor is a legal relationship defined by labor law, not a private agreement between an employer and worker. The Fair Labor Standards Act is complicated, but a worker looks like and “employee” if some of the following are true:

  • The employer focuses not just on deliverables and deadlines, but on where, when and how the work gets done. If you want the person working from 8-to-5 during the week, or you give the person a workspace where they’re expected to report in, that’s an employee.
  • The employer directs how the work is done rather than what he or she wants the final product to look like.
  • If the employer provides training, uniforms, supplies, that’s working with an employee.
  • Hiring an independent contractor who used to be an employee is a huge red flag to the IRS as well as other agencies. It’s best to hire someone who has had his or her own company for a significant period of time, paying his or her own taxes.
  • Hiring a contractor for multiple consecutive engagements looks an awful lot like giving the contractor a job in the eyes of the courts.

So how do you make sure you’re not fudging the line, even on the least detail about the relationship between your company and the people you hired? Well, you can get an expert to go over the Fair Labor Standards Act with you. Or, you can come to RISE next week, May 15, at 4 p.m. at 300 W. 6th St., suite 2250, where I’ll lead a workshop that helps you identify the crucial differences between employees and contractors. https://www.riseglobal.org/sessions/detail/consultant-contractor-or-employee




We work with companies on a project basis or on retainer, providing a custom level of HR help designed for your business, with offices in Austin, San Antonio, Dallas and Houston. Contact me at Caroline@valentinehr.com or call (512) 420-8267.

One Response to “The Fine, Dangerous Line Between Employees and Contractors”

  1. Wayne Vermillion

    From a contractor POV, different companies create employee vs. contractor distinctions differently. For instance, Dell Computers has a nine-month limit on any particular contractor tenure – 1440 hours, about nine months -, followed by a mandatory 30-day (IIRC) absence before commencing a new or renewed contract. This is waivable in special cases at the Dell VP level. IBM has a limit of 18 months in a single stint, and a total “months within years” limit, which are almost impossible to waive. In fact, I’ve heard IBM referenced as the losing defendant in a decades-old discrimination suit wherein a long-time contractor argued that since he was effectively an employee when he signed documents on behalf of IBM, he was entitled to California’s generous employee layoff benefits at IBM’s expense.

    OTOH, Texas state government has no contractor tenure limits, and some contractors have been doing the same job in the same office for years at a time. Also, immediate post-retirement contracting is common in state government. Defense contractor uniform-to-suit conversions are probably the worst current example of this revolving door. Xerox was notorious for the latter practice years ago, when retirement benefits were luxurious and available relatively early. I can tell you that the retired employees who were immediately hired as contractors assumed their former roles with nary a change in authority, and obviously acted as employees even when continuing to direct contractors in the “how” tasking as well as the “goal” tasking.

    I encountered a viciously petty but entirely legally protective restriction in state government when a purchasing director dictated that no contractors should receive the friendly, inter-office emails advising that an employee brought donuts, or that some other employee’s birthday was being celebrated with a cake in the break room. Petty, yes, but according to the letter of the law, what had to be done to differentiate completely between (presumed) employee and contractor.

    Keep up the good work of educating business!

    -Wayne V.