May 20, 2011

Job misclassification can cost you

Employment is still a lagging indicator of the fragile economic recovery. The latest figures show unemployment in Northern Colorado averaging near the state rate of 9.2 percent, slightly higher than the national rate.

Part of the problem is that employers are not yet confident in that recovery, especially how long it will last. Even though there is more work to do, there’s not necessarily enough money coming in to pay for a salary, which comes with payroll taxes, workers’ comp insurance, withholding, perhaps benefits, and the whole range of other costs associated with hiring.

So, why not just find an independent contractor to do the work? Then all those other costs are somebody else’s headache – unless the employer and/or the worker cut too many corners and wind up with misclassified employees.

And that can cost you. Since June 2009, if a Colorado employer is found to have misclassified employees as independent contractors in willful disregard of the law, that employer can be fined up to $5,000 per employee for the first incident and up to $25,000 for a second or subsequent misclassification.

Then there are the Internal Revenue Service fines, which can range from $1,000 to $5,000, not to mention potential liability if the workers seek reimbursement for unpaid wages and benefits or make other claims under state or federal labor laws. The IRS is in the second year of a three-year audit of 6,000 randomly selected businesses who maintain independent contractor classifications.

The 2011 federal budget includes $25 million for the Department of Labor to hire 90 new investigators and 10 new lawyers to target worker misclassification. That could be money well-spent from the government’s point of view, since the General Accounting Office estimates that worker misclassification costs $2.72 billion in federal revenues annually.

Misclassification can be particularly tricky for very small businesses approaching the magic number of 50 employees, where certain requirements, such as benefits created by health-care reform, kick in.

So why would an employer take the risk?

“It’s a huge cost-saver upfront,´ said Blair Trautwein, an attorney in Fort Collins. “It can be very tempting for small employers who don’t have to provide benefits or pay unemployment or Social Security or workers’ comp. But they have to make sure that someone is taking care of those things, or the government will come back at them.”

Employee or contractor?

A good place to start ensuring that your independent contractor is independent is with an employment contract.

“If you’re hiring a contractor, you should have the terms of employment spelled out,” Trautwein said. “Who is responsible for what, when you will get paid and for what, that sort of thing. It also helps if the contractor has created a business entity.”

The most important test to determine if a worker is truly an independent contractor is the question of control – behavioral, financial, and relationship. Who controls the person’s hours? Who owns the equipment he or she uses? Who determines what he or she will do on a daily basis?

“If a janitor shows up to clean a building with his own cleaning supplies, and knows that he can’t start before 6 p.m. but has to be done by 8 a.m., he’s an independent contractor,” Trautwein said. “If he shows up and the supervisor hands him a mop and a bucket and tells him to start over there and he can take a break at 10, he’s an employee.”

Companies that offer the services of their employees to perform tasks such as cleaning or temporary office work are obviously responsible for all the paperwork and taxes for their people. But working with individual contractors can be less clear cut.

Trautwein used another example of a personal assistant, who might be hired as an independent contractor but wind up driving his sole client’s car on errands at hours determined entirely by the client. He contrasted that with a neighborhood lawn mowing service, where the high-school entrepreneur makes a deal with a number of homeowners on the block and brings his mower over sometime every other Wednesday.

“The personal assistant looks more like an employee than the kid who mows the lawn, because of the level of control the employer exercises,” Trautwein explained.

And then who pays the taxes?

“Many ‘independent contractors’ are shocked to discover they are responsible for both sides of Social Security taxes, the employee’s and the employer’s,” Trautwein added – and that self-employment taxes are due quarterly.

It’s at that point that “contractors” can get angry and report the employer to the state Department of Labor and Employment for investigation, he said.

Employers can make the first move by requesting an advisory opinion from the state on the proper classification of workers. It has to be in writing and accompanied by a nonrefundable fee of $100. The labor department’s website lists about a dozen questions to address in the written request; by the time an employer answers them all, he or she will most likely have figured it out on his or her own.

“When in doubt, treat everyone as an employee,” Trautwein said he advises his business clients.

Employment is still a lagging indicator of the fragile economic recovery. The latest figures show unemployment in Northern Colorado averaging near the state rate of 9.2 percent, slightly higher than the national rate.

Part of the problem is that employers are not yet confident in that recovery, especially how long it will last. Even though there is more work to do, there’s not necessarily enough money coming in to pay for a salary, which comes with payroll taxes, workers’ comp insurance, withholding, perhaps benefits, and the whole range of other costs associated with hiring.

So, why not just find…

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