An individual or a business can engage (i.e. contract) with another as an employee or an independent contractor. The business owner is usually better served if he or she can categorize a worker as an independent contractor rather than an employee. In fact, most business owners would probably prefer all independent contractors rather than employees. If properly categorized as an independent contractor, the business owner need not fear liability for the contractor or the contractor’s work. The business owner need not pay employment taxes or withhold federal income taxes. The business owner need not pay unemployment taxes or into the Labor and Industries insurance funds. But, the decision to treat new or existing hires as employees or independent contractors can have serious consequences for your business. And, the misapplication of the classification (as either an independent contractor or employee) can lead to liability for the business and the business owner. Though the business owner may prefer the independent contractor relationship, the law requires an analysis of the relationship and the precise application of the status.
What is an employee?
An employee is an “agent employed by [an employer] to perform service in his affairs whose physical conduct in the performance of the service is controlled or is subject to the right to control by the [employer].” Kamla v. Space Needle Corporation, 147 Wash.2d at 114 (2002). Employers are liable for the harm caused by employees through the theory of respondeat superior – a Latin phrase meaning loosely “let the master answer for his servant.” This legal action allows an injured party to directly sue the business for all harm caused by the employee as if the business itself caused the harm. Typical employees include restaurant workers, flight attendants, paralegals, factory workers, and teachers. All employees receive income reported on the IRS form W-2.
What is an independent contractor?
An independent contractor is a worker that “contracts with another to do something for him but who is not controlled by the other nor subject to the other’s right to control with respect to his physical conduct in the performance of the undertaking.” Id . The readily apparent examples of an independent contactor include the plumber you call to fix your sink, the lawn care provider that tends to your lawn, and the taxi driver you hire to take you to the airport. For each example, the person hiring the independent contractor expects to rely upon the skill and judgement of the contractor to complete the task. Further the hiring individual does not dictate many things about the engagement like: how the task will be performed, who will perform the task, the clothing or appearance of the worker, the time it will take to perform the task, the tools necessary for the task, etc. More precisely, the employer hiring the person inspects only the results of the work and not the means whereby it is to be accomplished.
Id. As the hiring individual has no control, the law provides that the hiring individual bears no responsibility (read: liability) for any harm caused by the independent contractor. For example, if I hire a lawn care service and the lawn care truck causes an accident while getting materials for my lawn, I am not liable to the third party that was injured. An independent contractor receives income reported on the IRS form 1099.
The Grey Area.
The question of status hinges on whether the hiring party has control. More precisely, the question is whether the hiring party retains the “right to direct the manner in which the work is performed, not simply whether there is an actual exercise of control over the manner in which the work is performed.” Id. The IRS looks to evidence of the degree of control by looking into three categories: (1) behavioral (does the hiring person have the right to control the manner in which the worker completes the job); (2) financial (are the business aspects of the job controlled by the hiring person); and (3) the type of relationship (written contracts, length of relationship, and benefits). Source: irs.gov.
Misapplication of Status.
A host of issues can beset a business owner that misclassifies the worker. On the legal liability side, the employer would be liable for acts of the employee, but if the employer treated the employee as an independent contractor, the business owner may not have appropriate insurance coverage but still the full liability. The employer may also be held responsible for back taxes (for both federal withholding and employment taxes that should have been paid). A business owner may also run afoul of sick time claims and overtime claims when an independent contractor is appropriately deemed to be an employee. An independent contractor properly classified as an employee may not qualify for labor and industry insurance and may then also hold the employer liable for the damages incurred. And, on a practical level, the misapplication can create conflicting employment expectations inherent in the separate expectations of an independent contractor and employee.
Talk to your accountant and attorney to ensure you are properly classifying your employees.
390573-2
* Licensed, not practicing.
The opinions voiced in this material are for general information only and not intended to provide specific advice or recommendations for any individual or entity. This information is not intended to be a substitute for specific individualized tax or legal advice. We suggest that you discuss your specific situation with a qualified tax or legal advisor.
Securities offered through LPL Financial, member FINRA/SIPC. Investment advice offered through Cornerstone Wealth Strategies, Inc., a registered investment advisor and separate entity from LPL Financial.
