Using contractors? 3 hidden pitfalls to avoid

More Finance execs than ever see the use of independent contractors (ICs) as a smart business decision. 

And with good reason. Employers can use ICs to avoid being subject to the healthcare reform law’s employer mandate and other employee-friendly laws like the FMLA and the ADA.

But in many cases, employers just aren’t aware of all finer points of the IC rules or the risks associated with this business practice.

The bigger picture

Whether your company is already using ICs or you’re planning on doing so in the near future, remember to keep these things in mind:

1. The feds have ramped up enforcement from all sides. Because using contractors has become so popular in recent years, the feds have made rooting out misclassification a top priority.

The DOL, EEOC and IRS have each added auditors and other personnel to aggressively go after companies that misclassify full-time workers as ICs.

And when employers are guilty, the feds often come at them from all different angles.

Example: First the IRS will come after guilty firms for their share and employees’ share of back taxes. Then, the DOL will look into any FLSA violations, which lead to civil penalties and back pay responsibilities.

2. The rules can be confusing. Even well-meaning employers can fall victim to misclassification. That’s because there are two different federal tests for determining who’s an IC.

The two tests are:

• FLSA’s “economic realities test,” and
• IRS’ “three-pronged test.”

And there’s no clear methodology for determining which test the feds or the court will use. Basically, it all depends on which test applies more to the situation.

Bottom line: The tests are very similar, so employers should make sure their ICs can pass both.

3. State law issues. Even if an employer’s ICs meet all of the federal standards, there are still state laws to worry about.

And some states have more strict classification guidelines than feds.

Here’s just one example: In Mass. and Ill., every worker is presumed to be an employee – and employers are required to prove otherwise.

So it’s possible for a company to correctly classify its ICs under the federal standards only to violate their state’s classification standards.

That’s why it’s critical for firms to be sure they pass both federal and state classification tests.