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Changing the nametag: Independent Contractors v. Employees

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If you are considering changing an employee into an independent contractor, wait.

First, weigh the actual benefits. Ask your lawyer, your liability insurance carrier and your CPA.

Second, determine what role the person really fills. Pretending an employee is an independent contractor may cause legal hassles.

Most businesses explore how to cut overhead and maintain productivity. I am no business process expert, but I know that numerous companies explore achieving “cost efficiency” by changing a worker’s status from employee to independent contractor.

The change should not be taken lightly. Employees and independent contractors may occupy the same amount of desk space at your business, but they differ in control of work, risk of loss and tax liability.

Who controls the work may determine whether a worker is an employee or independent contractor. Employees tend to have work directed through a hierarchy. For example, employees may have set arrival and departure times, breaks and vacations. Employers may discipline or terminate an employee for unsatisfactory performance. To the contrary, independent contractors typically enter contracts regarding the expected work product, control their own work and simply provide the deliverable work product. Independent contractors often set their work hours, breaks and vacations, subject only to the deadline of the work product.

The employer carries the risk of loss regard an employee’s work product. If the employee performs poorly, the employer suffers. Conversely, independent contractors carry the risk of loss regarding their work product. Depending on the terms of the independent contractor agreement, the employer may terminate a contract with an independent contractor for poor performance, and may even bring legal action based on breach of contract.

The Iowa Department of Revenue and the Internal Revenue Service (IRS) also have an interest in how a business classifies its workers because of tax liability. Employers withhold and pay taxes to the federal and state government regarding earnings, social security and certain other benefits. Federal and state governments also offer certain rights and protections to employees versus independent contractors (See, for example, Title VII of The Civil Rights Act of 1964).

Thus, governments have an interest in both protecting workers and collecting tax revenues. Given the budgetary issues of late in the federal and state governments, there have been increased audits focused on misclassification of workers as independent contractors. When found, the IRS may reclassify workers as employees and assess back-taxes as well as interest and penalties. Iowa also charges fines, back-taxes and penalties for misclassification of workers. These accumulate quickly and can be taxing (pun intended) for businesses when hit.

Resources are available to assist businesses in determining whether a worker is an employee or an independent contractor. The IRS provides tips for small businesses and allows questions to be submitted on Form SS-8 for worker status determination. The Iowa Department of Revenue also provides a website to guide in this determination. Finally, the IRS has a guide and Iowa Workforce Development has a guide for determining correct worker status determinations.

A rose by any other name would smell as sweet.-Shakespeare

An Employee by any other name may stink.-IRS

- Christine Branstad

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