Are Your Workers Employees or Independent Contractors?

Organizing a workforce for your San Diego business presents formidable challenges.  One of those challenges is deciding whether to hire staff as independent contractors or as regular employees.  Obviously, there are fiscal advantages to hiring independent contractors.  For those workers classified as “employees”, withholdings, payroll taxes, worker’s compensation, and compliance with labor laws generally add about 18% to your payroll costs, and this is exclusive of employee benefits.  Hiring independent contractors is an appealing alternative, but it’s not as simple as treating all workers as “independent contractors”.  Federal and State law dictates whether a worker is an “independent contractor” or an “employee”.  


When the time comes to hire staff, it is crucial that businesses ensure that workers are properly classified under Federal and State law.  Even large corporations have fallen victim to the assumption that classification of its workers as independent contractors was appropriate.  Microsoft Corporation, Hewlett-Packard, Time Warner, Allstate and FedEx have all borne the cost of litigation regarding the misclassification of workers.  Since 2007, estimates of settlements in worker misclassification cases approach one billion dollars.  Nonetheless, employers continue to opt for the “independent contractor” classification while treating staff as employees opening themselves to significant tax liabilities, interest and penalties.  

Part of the problem lies in the ambiguity in existing regulation lending to subjective determinations.  In California, the Employment Development Department offers the following guidelines for the definition of an “employee”:  the employer has the right to discharge the worker at will; the work is usually done under supervision; the worker does not provide the tools, equipment, or place of work; the worker is paid based on time worked or piece rate; the worker has little or no meaningful discretion on how to do the job; and the worker does the same kind of work as that which is the principal production of the company.

Under these guidelines, it is easy for unwary employers to convince themselves that they are properly classifying workers as independent contractors.  This is often done through rose colored glasses without fully understanding the consequences of misclassification.  If the I.R.S. or state tax agency determines that a business’ workers are misclassified as independent contractors, the business will be subject to back taxes, interest and penalties which can be significant.   In most cases, especially for smaller businesses, the issue of misclassification never arises.  Workers classified as “independent contractors” fear challenging their employer’s determination. Nonetheless, employers that currently classify workers as independent contractors should reevaluate the classification, particularly as tax agencies are increasingly viewing the use of independent contractors with suspicion.  If there is any doubt, employers can seek the advice of a business attorney and/or file a Form SS-8, Determination of Worker Status for Purposes of Federal Employment Taxes and Tax Withholding.

There are advantages to hiring workers as employees which businesses often overlook.  Most significantly, employees appreciate the security that comes with what they consider a “real job”, especially when the job comes with benefits.  While it may seem counter intuitive, employees actually feel more secure knowing that deductions are being taken from their salary.  Happy employees secure in their position are loyal and productive employees – two qualities that are too often underestimated by business owners.  Employees are more flexible and can be utilized in different capacities.  An independent contractor’s focus is most often limited to that which they are contracted for.    

Of course, every business has its own unique requirements and whether hiring workers as independent contractors or as employees is best for your business will depend on your specific business and business goals.  Whatever the decision, it is critical that you evaluate your workers’ roles before classifying them as independent contractors.  The consequences of misclassification can be significant.  In the end, the government considers most workers to be “employees”.  Business owners should therefore proceed with caution when making the classification and consider contacting a San Diego business attorney if they remain uncertain. 

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