If you're a businessperson looking to contain costs--and isn't--you've probably considered hiring independent contractors instead of employees for work your business needs done. Independent contractors, or ICs, are people who contract to perform services for others but don't have the legal status of employees. Businesses can save time, money and headaches by hiring ICs instead of employees.
There are at least eight million ICs in the United States, and at least 60% of all businesses use them. These numbers are growing rapidly. ICs can perform, many jobs ranging from construction to accounting to computer programming to nursing.
Using ICs entails both benefits and risks. You might be at a competitive disadvantage if you fail to hire ICs. On the other hand, there can be serious consequences if you misclassify employees as ICs.
Benefits of Hiring ICsOne of the main reasons businesses prefer ICs to employees is the cost savings. In addition to salaries or other compensation, employers usually must pay employee expenses such as:
- federal payroll taxes, including a 7.65% Social Security tax and a usually small (.08%) federal unemployment insurance tax
- state unemployment insurance premiums
- workers' compensation insurance premiums
- employee benefits (ie) health insurance, paid vacations, sick leave, retirement benefits and life or disability insurance
- office space and equipment
These expenses add at least 20% to 30% (often more) to payroll costs. For example, if you pay an employee $10 per hour, you will probably pay another $2 to $3 per hour in employee expenses. You incur none of these expenses when you hire an IC. So even though ICs are often paid more per hour than employees doing the same work, they still cost less in the end.
In addition, when you hire ICs instead of employees you have reduced exposure to some types of lawsuits, such as those alleging job discrimination or wrongful termination.
Finally, and most important for many firms, ICs provide a level of flexibility that can't be obtained with employees. You can pay an IC to accomplish only a specific task, allowing your business to get specialized expertise for a short period. You need not go through the trauma (not to mention potential severance costs and lawsuits) of laying off or firing an employee. Moreover, an experienced IC can be productive immediately, eliminating the time and expense involved in training employees.
Risks of Using ICsDespite the advantages, many businesses are uneasy about using ICs because they have heard about or experienced the consequences of misclassifying ICs workers who are, legally, employees. And it's true that the consequences can be economically devastating. A business must pay the IRS all back taxes owed, with interest, plus a penalty of 12% to 35% of the tax bill.
In one case, the IRS claimed that the owner of a logging company had miclassified tree fellers as ICs. It demanded more than $211,000 as retroactive payment of taxes that should have been withheld plus penalties. The logger took the IRS to court and eventually won-the court agreed that the tree fellers were ICs. But it was a Pyrrhic victory. The litigation expenses were so great the logger declared bankruptcy, lost his business and ended up living in an abandoned school bus.
Audits by state agencies are even more common than IRS audits. State audits most frequently occur when workers classified as ICs apply for unemployment compensation after their services are terminated. An investigation by your state unemployment compensation agency will ensue, and you will be subject to fines and penalties if it is determined that workers should have been classified as employees for unemployment compensation purposes.
Another major disadvantage of hiring ICs is the potential for law suits due to negligence if they are injured on the job. This is something employees covered by workers' compensation normally cannot do.
Who Is an IC?Most people that qualify as independent contractors follow their own trade, business or profession-that is, they are in business for themselves. This is why they are called "independent" contractors. They earn their livelihoods from their own independent businesses instead of depending upon an employer.
Good examples of ICs are professionals with their own practices like doctors, lawyers and accountants. For example, dentists who have their own practices are independent businesspersons offering dental services to the public; although you pay your dentist for work, he or she is not your employee.
A worker doesn't have to be a professional, however, to be an IC. A person you hire to paint your office or mow your lawn can be in business for himself or herself and qualify as an IC.
Unfortunately, it can be very difficult to know for sure whether someone is an employee or IC. There is no single, clear-cut test for classification. Slightly different legal tests for determining worker status are used, or at least paid lip service to, by various government agencies, including:
- the Internal Revenue Service
- state unemployment compensation insurance agencies
- state workers' compensation insurance agencies
- state tax departments
- the United States Labor Department
- the National Labor Relations Board.
Each of these agencies is concerned with worker classification for different reasons, and has different biases and practices. Each agency normally makes classification decisions on its own and need not consider what other agencies have done, though they are often strongly influenced by it. As a result, it's possible for one agency to find that a worker is an IC but another company classifies him/her as an employee. It's also possible, though rare, for a worker to be deemed an IC in one state and an employee in another.
The result is a legal morass that confuses and frightens hiring firms. The only way to successfully wade through this legal thicket is to spend some time and effort learning how these government agencies go about classifying workers.
