In 2005 there was estimated to be over 10 million people operating as independent contractors. Small, medium and large companies all use independent contractors to remain competitive and to grow their businesses but understanding the differences between an “independent contractor” and a regular “employee” is neither easy nor trival to the business. It is an area that is riddled with traps for the unwary. According to a Department of Labor study, approximately 38% of small businesses misclassify employees as independent contractors. The problem is not limited to small businesses. Even large, more “sophisticated” companies, such as Microsoft, Federal Express and Wal-Mart, for example, are not immune to this error. Given the current market conditions, it may be even more important for a business to get the classification correct. Tax revenues for all levels of government are down while budget deficits are up. In an attempt to bridge this gap, the Federal government and state governments are going to be taking a closer look at how companies classify their human resources.
There are many reasons why this classification is often hard to get right. Realize that just because you, the employer, think of the person you hired as an independent contractor, the contract itself might state that he or she is an independent contractor and even the person thinks of themselves as an independent contractor but that doesn’t necessarily mean that they really are an independent contractor. Furthermore, a person may be an independent contractor under one set of laws but will be considered as an employee under another set of laws. The tests to determine whether a person is an employee or an independent contractor may be different depending on whether it is for taxes, compliance with discrimination laws or the operation of respondeat superior or some other law. At least for the purposes of determining whether the right taxes have been withheld it is up to the company to prove that the person was properly classified as an independent contractors and should not have been considered an employee.
New Jersey uses the “ABC” test for unemployment responsibility and hour and wage requirements. NJSA 43:21-19. Under this test it is up to you, as the employer, to prove that the relationship is that of an independent contract and not that of an employee. Specifically the state would look at the following:
A. Is the person now and continues to be free from the control and direction over the performance of the job? This condition not only has to be in a contract but must be what occurs in fact. If the actual practice is different than what is set forth in the contract, the contract will have little weight.
B. Are the services either outside the usual course of the business or performed outside your physical location? Does the independent contractor work in your office space or do they work from their own location?
C. Is the individual customarily engaged in an independent established profession or business? Are you the independent contractor’s only job or does the indepenent contractor perform work for several other companies?
The business must be able to prove that independent contractor meets all three prongs of the ABC test and it is important that a business gets the decision right. Failure to meet all requirements could result in the payment of all back taxes, penalties and interest. Such ramifications could transform a company from a success to barley surviving or worse. It may even open the business owner to personal liability for the back taxes.
As a business owner, it is crucial that you fully understand the differences between a true independent contractor and an employee. You must fully understand what need you are trying to fill by the proposed relationship and then structure it to adequately meet your proposed business need so in order to avoid possible issues in the future.