Employee or Contractor? One of the Most Expensive Mistakes Startups Make
When a small business opens its proverbial doors, it rarely needs an onslaught of full-time employees. Many business owners start small. They hire consultants and freelancers as needed, to keep costs down. As the business grows, the need for those workers increases. Suddenly, there are contractors working full-time hours. Or are they employees now?
Considering the cost of employees, it’s easier to say, “no”. Employees are expensive. Think of the overtime, the benefits, the tax and payroll expenses, the government regulations, to name a few. So, why not keep these workers as contractors and call it a day?
A well-meaning business owner might not realize that this is illegal. Misclassification is a common violation of the Fair Labor Standards Act (FLSA). Violating the FLSA is time-consuming and expensive.
What Makes A Worker An Employee?
There is no cut-and-dry way to determine whether a worker is an employee or contractor. However, most workers are employees. The Department of Labor (DOL) offers some factors that the U.S. Supreme Court considers significant in determining a worker’s classification. But that, too, isn’t crystal clear.
When considering if a worker is an employee, consider some of the points below:
Do you pay this person as part of employee payroll?
Do you define their working hours?
Do you provide the necessary equipment and/or software to do their job?
Do you require them to submit time off requests?
Do you have contractors reporting to other contractors?
If you answered “yes” to any of the above questions, that worker is an employee.
Contractors are their own employers, and those who pay them are clients. They provide their own equipment, determine their own hours for the most part, and have more freedom to make decisions and take action than employees.
Some small business owners believe it’s up to their discretion whether a worker is a contractor or employee. Some industries have a long history of misclassifying their workers as contractors. Others believe that if a worker signs a contract stating they are a contractor, then they’re protected against misclassification.
None of these beliefs are true, and none are a legal defense against misclassification.
State Requirements
While the Federal government does not have any single test to rely on, states may have their own standards, requirements, and penalties.
California is known for having strict requirements for classifying workers as contractors. They employ the “ABC Test”. Per state legislature, an employee must meet all three of the following criteria:
The worker is free from the control and direction of the hiring entity in connection with the performance of the work, both under the contract for the performance of the work and in fact;
The worker performs work that is outside the usual course of the hiring entity’s business; and
The worker is customarily engaged in an independently established trade, occupation, or business of the same nature as that involved in the work performed.
Employers should be aware of the worker classification laws in every state in which an employee works.
The Cost of Misclassification
Tax penalties can go back as far as three years and include daily interest. The penalties can equal nearly half of that worker’s wages over those three years. If an employer is found to have misclassified employees on purpose, they could face jail time and up to half a million dollars in fines.
And that’s just the IRS.
The DOL has its own penalties and regulations. Similarly, they can go back as far as three years.In many states, these penalties and restrictions go far beyond Federal requirements.
This is only scratching the surface of penalties. Government misclassification assessments can lead to these same agencies and others conducting in-depth audits only to find more potential liabilities.
Finding the Right HR Support
Staying on top of state and federal employment is complicated and time-consuming. Business owners have enough on their plates. When hiring a full-time HR employee doesn’t make sense, contact an HR consultancy. They provide the HR support you need, and only the support you need. They provide only the HR support you need, whether you’re at employee one or one hundred.
PageHR can help you audit your employee classifications. to assist in keeping your business compliant. We will guide you and keep you compliant. If you are unsure of your current workforce classification, we can help you get back on track and stay on track. We work with clients to assess and build your HR initiatives from the ground up.
“The world is changing every day. It is always better to walk the compliance path with an experienced team of professionals behind you!” - Mel Femyer, HR Generalist
Contact us today to see how we can support your business.