Labor Law: Employee or Independent Contractor?

One of my colleague’s clients recently found itself in trouble with the IRS and its insurance company for incorrectly designating several of its employees as independent contractors. The employees had been with the company for at least a year when the company decided to restructure the relationship to “save money.” The company laid the employees off only to hire them back as independent contractors the following week. The idea was that by designating the employees as independent contractors the company would not have to pay payroll related taxes and could cut down on the amount it spent on insurance benefits.

Several months after designating the employees as independent contractors, one of the employees wrecked his truck while working for the company. The company was held liable for the accident, but because it did had not identified the driver as an employee for insurance purposes it was prohibited from claiming coverage under its insurance policy.

In addition, it is my understanding that the company has recently had penalties levied against it by the IRS for failing to pay employee related taxes.

Autonomy versus Control
The company failed to understand the biggest factors in distinguishing an employee from an independent contractor: (1) the ability to control how the individual performs the job; (2) whether the individual uses his own or the company’s equipment; (3) how the individual is paid; (4) where the individual works; (5) when the individual works (i.e. set work day schedule).

Recommended Precautions
What could the company have done to avoid problems with its insurance and the IRS? Consider the following:

The company may have been able to address the above factors and ensure the individuals received the treatment the company wanted them to have by (1) having the individuals sign an agreement acknowledging their status as independent contracts; (2) requiring the individuals to obtain their own business licenses, tax identification numbers, places of business and other clients; (3) allowing the individuals to control the manner in which their work was performed (i.e. does the company give “instructions” to the individuals or merely make “suggestions.” Instructions are indicative of an employee, Suggestions are indicative of an independent contractor); (4) not hiring former employees and designating them as independent contractors. The company may have considered hiring the individuals through an employment agency.

When In Doubt, Designate As An Employee
But probably the most important precaution the company could have taken is to have treated the workers as employees when it had doubts as to their correct classification. The company may have even asked the IRS to give an opinion on the classification. Trust me, it would have been far better for the company to have taken the above steps than to attempt to clean up the mess they are now in.
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