Misclassifying Employees as Independent Contractors ... One of the Most Expensive Mistakes of Them A
The time comes for every successful home-based business ownerwhen one person can no longer do it all. In the early days ofyour fledgling business you accepted that not only were you CEO,CFO, COO, secretary, treasurer and marketing director, you alsohad to be laborer, receptionist, janitor, chief cook andbottlewasher. That is simply what you have to do when startingout. In fact, I'll bet you worked harder in your "little homebusiness" than you ever did in your former life as corporatewhatever, right? But now the time has come. You havesuccessfully taken your business past the initial, maddeninglyslow, frustrating start-up phase to the point where you'reseeing some growth ... so much growth in fact that you'refinding it near impossible to keep all the balls in the air.The time has come to hire some help. OK, but what kind of helpdo you need? If it's a secretary/receptionist, that's easy. Yougo out and hire yourself a competent employee. But what if it'ssomeone to carry out specific projects such as designing awebsite for a good customer you just can't service within thetimeframe the customer needs? What if it's someone to create amarketing program to launch your business to the masses? What ifit's a bookkeeper to handle your accounts payable, receivableand everything else in between? The difference between thesetypes of activities and our secretary/receptionist example isthat the former are all specific projects whereas the latter isnot.When considering whom to hire for your project work, you have achoice ... hire a full-time or part-time employee or hire anindependent contractor. By the time you include all the add-oncosts of hiring an employee (in addition to wages or salary youneed to add on federal and state payroll taxes, social securitytax, federal unemployment insurance tax, state unemploymentinsurance, workers' comp premiums and employee benefits, not tomention shelling out for office space and equipment), hiring anemployee becomes a relatively expensive option compared tohiring an independent contractor to do the same work. The add-oncosts of hiring an employee usually add about 30-40% to thebill. In other words, if you pay your employee $10 an hour,you'll really be paying $13 - $14 an hour once you include allthe add-on expenses.In contrast, although you usually pay an independent contractormore than an employee, that cost will still be less than anemployee with the add-on expenses. You may pay an independentcontractor $12 an hour without any additional charges. Soundgood? Well, read on. It's not as easy as it looks.WHAT IS AN INDEPENDENT CONTRACTOR?So, what is the difference between an employee and anindependent contractor anyway? Quite simply, an independentcontractor is someone who contracts with s...
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...omeone else to providespecified services for a set price on terms and conditionsoutlined in the contract.For example, let's say you hire a gardener to mow your lawn andget rid of weeds once a week. Your contract (whether written ornot) is that Joe Gardener will arrive at your house on Fridaymorning, mow your lawn, get rid of weeds and generally tend toyour garden. In exchange, you agree to pay Joe $40 for thisservice each week. Joe supplies his own lawnmower, hedgeclippers and weeding tools. Joe decides what time he arrives andhow long the job takes (within reasonable parameters). You donot supervise Joe in his tasks or dictate to him how they are tobe done. Joe is an independent businessperson and you treat himaccordingly. The final product is either to your satisfaction orit isn't. When he's finished, you pay him if you're satisfiedwith the end result and you don't pay him if you're not.Contrast this with an employer/employee situation. Let's say youown the business Joe's Gardening Service. You employ threeemployee gardeners to perform services for your business. As thegardeners' employer, you pay them a fixed wage and you withholdtaxes, unemployment insurance and various other benefits fromtheir wages to remit to the appropriate government agencies. Inaddition, you provide your employees with the tools andequipment they need to perform their work. You tell them what todo and supervise them while they're doing it. At the end of thejob they get paid by you whether your customer is satisfied withthe job or not. In other words, although your customer may notpay you (the independent contractor) because she is dissatisfiedwith the work performed by your employees, you must still payyour employees because they are not independent contractors -they are your employees and are entitled to be paid a fixedwage. If you are dissatisfied with their work, you can fire thembut you can't decide whether to pay or withhold their wagesbased on the end result of the particular project.ADVANTAGES OF INDEPENDENT CONTRACTORS=> CostAs mentioned above, the main advantage of independentcontractors versus employees is cost. You can get the same orbetter service from independent contractors for a lower hourlyrate than you can from employees because you don't have to incurall the add-on expenses that go along with hiring employees.=> Equipment and MaterialsIn addition, you don't have to provide office space or materialsand equipment to independent contractors. As independentcontractors (who may also go by the terms "freelancers","consultants", "self-employed", "business owners" etc.) areself-employed business people, they have their own "tools of thetrade". If they're website designers, they have their own officespace, computer and prin...
...ting equipment. If they're gardeners,they have their own lawn mower, whipper-snipper, wheelbarrow andpruning shears.=> Legal LiabilityAt law, an employer is vicariously liable for the torts of hisor her employees. This means that if you hire an employeegardener who accidentally runs over your customer's pet cat inthe driveway of her home when the customer had made it clearthat your employees are always to park in the street, inaddition to suing your employee for negligence, she can also sueyou, the employer, as you are vicariously responsible for theacts of your employees. (And, by the way, this applies wheneveryour employee is acting within the scope of employment, whetherunder your express instruction or not. If your employee has acar accident when traveling between jobs and his negligence atleast partially caused the accident, you're responsible to thesame extent as the employee.)This is generally not the case with an independent contractorunless the independent contractor has been engaged to perform aninherently dangerous activity (such as blasting) or you haveattempted to delegate to your independent contractor anon-delegable duty (such as keeping a rental property you own ingood repair for the benefit of the tenant).In addition to minimizing legal liability for torts, hiringindependent contractors also minimizes your liability for othertypes of lawsuits such as wrongful termination or jobdiscrimination.DISADVANTAGES OF INDEPENDENT CONTRACTORSThere are two main disadvantages to hiring independentcontractors versus employees.=> MisclassificationFar and away the most serious disadvantage is if you misclassifyemployees as independent contractors. Merely labeling a workeras an independent contractor is not enough. They must actuallybe an independent contractor.If you do misclassify an employee as an independent contractor,you must pay the IRS all back-taxes owed, plus interest, pluspenalty (12% - 35% of the total tax bill).Also, you expose yourself to an increased risk of state auditswhen your terminated independent contractor files forunemployment benefits. Never mind that you and your independentcontractor intended that there be no employer/employeerelationship, many's the disgruntled independent contractor whounilaterally decides to recategorize the relationship as one ofemployer/employee when the spectre of unemployment benefitsraises its pretty head. In such situations, you'd better be ableto protect yourself by proving that the arrangement was for anindependent contractor and not an employee.=> Legal LiabilityUnlike an employee who is limited to workers' compensationbenefits, an independent contractor can sue you for negligenceif they're injured on the job. That's what liability insuranceis for though.
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