By Jamie Moore Marcario
We get it. You’re the new biz on the block and you need help. But the thought of hiring employees freaks you out! Where will you get the money? So you hire an independent contractor (IC) instead. You pat yourself on the back. Maybe you tell your best friend, “I’m brilliant! I hired someone to do my bidding and I’m saving a ton in payroll taxes. I am the bomb!”
But what if the real bomb is that IC that’s going to explode right in your face? If you don’t engage the right IC for the right job—a mistake the IRS and the NLRB call “misclassification” — you might be on the hook for fines, penalties, back wages, overtime pay and possibly a lawsuit that could sink your business. To make sure that doesn’t happen to you, check out these pros and cons of working with independent contractors. Use them as your guide on when and how to hire them without blowing up your business.
Independent Contractor Pros
Pay Now or Payroll: Why IC’s are Not Necessarily Cheaper than Employees
An independent contractor probably charges more per hour than you’d pay an employee to do the same job. But you’ll might SAVE big bucks because you won’t have to pay all the expenses that accompany standard employees. For example, employees need office space, equipment and materials to do their job, and you have to pay for all that. Independent contractors need all those things, too, but that’s not your problem! It’s theirs.
If you hire employees, you’re on the hook to pay your share of their Social Security and Medicare taxes, as well as state unemployment compensation and workers’ compensation insurance. With an independent contractor, you pay none of those. Employees get benefits like 401K plans, health insurance, paid-time off, and vacation time. IC’s don’t.
But be careful. If you hire someone as an independent contractor who you treat an awful lot like an employee, you could be on the hook for IRS penalties and fines, and maybe even a lawsuit. Remember, if it looks like a duck, walks like a duck, and squawks like a duck, it’s probably a duck. Saving a few bucks now is not worth the hassle of fighting the IRS later because you accidentally misclassified your IC.
The Lowdown on Legal Liability for ICs
True. Employees enjoy the protection of a wide array of federal and state employment laws. These laws vest employees with more rights to sue their employer on grounds like discrimination and harassment than the rights guaranteed to independent contractors.
An independent contractor might still sue you, but the causes of action they can bring are seriously limited as compared to an employee. For example, the law guarantees employees the right to be paid a minimum wage, to be protected from discrimination and harassment in the work place employment discrimination protections, to be paid for sick leave or family leave, and to form unions in certain states. Independent contractors are not entitled to these protections.
Most importantly, employees can sue employers for wrongful termination; independent contractors can’t. Independent contractors are generally limited to bringing a breach of contract action pursuant to the terms of the contract between her and you. And if you had a good attorney r=negotiate, draft or revise the contract, the majority of the terms of any IC agreement should be favorable to you.
However, keep in mind that an independent contractor, even one who wanted an IC arrangement initially, can bring a suit as an employee if he or she alleges he was an independent contractor in name only; he practically functioned as an employee. To avoid suits like this, be sure you treat independent contractors like independent contractors, NOT employees. Mark the line between them clearly. And if you’re not sure how to do that, contact a great legal team to help you.
Staffing Up to Meet Capacity is Easier
By engaging independent contractors, you have more freedom and flexibility to staff your company up or down to meet the ebb and flow of capacity demands. Changes in the market or your company’s workload won’t result in hiring frenzies or mass layoffs if the bulk of your work can be performed by ICs.
If you’re just starting your business and don’t know what demand for your products and services will be like, reliance on ICs can be a smart decision for these reasons. You can hire ICs for a specific task or project with the freedom to walk away from the relationship with no hassles when the work is done.
Independent Contractor Cons
You’re not in control
True independent contractors require no oversight, no training, and no physical space provided by you. Some see this as an advantage. But the tradeoff for the minimal investment required is that you have little control, if any, over how an IC actually does the work you hired her to do.
Although you’re able to dictate the outcome you want from the work produced by your IC, she otherwise has total “independence” when it comes to when, where, and how she completes the tasks you assign to her, so long as the end product satisfies the quality and deadline requirements outlined in your contract with her.
Permitting those who perform work for you could be tough if you’re a business owner who prefers that work be completed using specific processes, procedures, or tools. If that describes you, it’s absolutely critical that you discipline yourself not to interfere too much with the IC’s work because if you interfere too much, you might find the IRS knocking at your door demanding that you reclassify the IC as an employee. And those actions almost always result in hefty fines, penalties and other expenses.
The IRS May Come Knock, Knock, Knocking’ on Your Door
As I alluded earlier, if you hire a bunch of ICs instead of employees, your chance of an IRS audit goes up exponentially. Why? The IRS has a vested interest (in terms of taxes and insurance payments) in ensuring you maintain an appropriate relationship with independent contractors and that you convert them to employees whenever possible.
And it’s not just the IRS that can audit your business. A number of federal and state agencies, like the Department of Labor and your state’s unemployment compensation agency, can audit or investigate your company if they think you’re misclassifying employees as ICs.
The bottom line is this: if you hire ICs, be sure you take the appropriate steps to treat your contractors as truly “independent” from your business or be prepared to pay the price.
Increased Fights Over Contractual Terms and Intellectual Property
While ICs can’t sue your company for wrongful termination, that doesn’t mean they have zero grounds on which to sue your company. The verbal or (hopefully) written contract you both signed controls all aspects of the employment relationship, including your ability to terminate the independent contractor.
Depending on the contract terms, you may not be able to fire an IC as easily as you would an employee. Moreover, if the IC feels you’ve violated the terms of the contract, she can sue you for breach of contract, which could leave you on the hook for attorney’s fees and potential damages.
Commonly, independent contractors and their business clients, like you, fight over the ownership rights to intellectual property related to the work the independent contractors complete for the company. Unlike an employee relationship where the employer automatically owns the copyrights, patents, and other intellectual property rights to the work produced by the employee, in an independent contractor relationship, the IC owns the intellectual property rights to what he produces by default. Unless your contract with the IC says otherwise, be prepared to fight over these rights if things go south with your IC. Be sure you have a “work for hire” clause in all of your independent contractor agreements to ensure you own the rights to anything created by your ICs.
At Thrive LawTM, we’re your trusted advisor when it comes to employment law and worker classification. If you’re trying to decide whether to hire independent contractors versus employees, or you need to ensure your independent contractor agreements offer your company the best protection from liability, we’re here to help.
This article is an educational service of Thrive LawTM, a business law boutique. It does not constitute legal or tax advice or imply an attorney-client or accountant-client relationship. At Thrive Law, we offer a full spectrum of legal services for businesses and are equipped to help you make the wisest choices about your business dealings while you’re alive and well or in the event of your incapacity or death. We also offer a Healthy Business & Creative Checkup for ongoing ventures, as well as outsourced company counsel plans for businesses who need a legal team on speed dial. Contact us today to schedule: 727.300.1990 or firstname.lastname@example.org. We cannot wait to meet you!