Hiring independent contractors can be beneficial for many organizations. However, those contractors can pose a significant risk to employers. While the classification of them as contractors instead of employees may seem black and white to employers, it is anything but. Employment laws, rules, and regulations vary from state to state. To complicate matters further, some state laws are stricter than federal laws. Navigating this terrain can be complicated for employers – and potentially costly.
Penalties, Taxes, and Fees, Oh My!
There are plenty of legitimate reasons why businesses take on independent contractors: to help with projects that are limited in duration and scope, to access specialists with unique skills not available in the current workforce, to enter new markets, etc. However, both federal and state governments are under enormous pressure to collect back payroll and unemployment taxes from companies that incorrectly classify independent contractors.
Why the concern? In some cases, the contractor themselves may not be paying appropriate taxes on the income they are earning from a company. In that case, it is the company who is ultimately held responsible for paying taxes to the federal government. Unfortunately, even good intentions aren’t enough to shield employers from government audits that can and do result in massive collections of taxes, fees, and penalties. It is up to every employer to understand all the regulations that could affect them.
Size Doesn’t Matter (To the Government)
Many small organizations and nonprofits with tight budgets hire independent contractors to save money. The government does not make exceptions for company size, however, and small groups can be crippled or even forced to close under the weight of government action. In 2009 a small kickball and softball umpire’s association in Howard County Maryland found itself in hot water over their use of independent contractors. An umpire filed for unemployment compensation after being let go from his day job, and listed the umpire’s association as a source of income. This triggered an audit, which resulted in the state demanding over $15,000 in unpaid unemployment taxes from the association.
The move shocked the small group, who, at the time of the audit had only $3,000 in the bank. The umpires worked for a recreational league, and were free to accept or decline games at any time. None of the officials working for the league classified umpiring as their full-time job, but rather as a hobby. The organization never believed it was doing anything to skirt the law, but their intentions weren’t enough to save them from a costly situation. Eventually, Maryland updated its regulations and exempted the organization, saving them from potential financial ruin. Even though the state is working to ensure that law-abiding groups aren’t negatively affected by audits, all companies and organizations, regardless of size, are expected to be aware of, and comply with, all employment regulations.
Do You Know Who Your Vendors Employ?
Business owners should also be aware that they can also be held liable for a vendor’s misclassification or misuse of independent contractors. In 2005, Wal-Mart found itself owing $11 Million to the federal government over charges that one of their cleaning vendors employed undocumented immigrants to clean hundreds of stores.
While the investigation concluded that the retail giant did not have direct knowledge of the illegal hiring practices of the vendor, prosecutors contended that Wal-Mart was still culpable. The cleaning company responded to the RFP with a bid that was so low, there would have been no way to meet that threshold if the company had paid legal wages to legal workers. The court agreed with the prosecutors’ assessment that Wal-Mart should have known this, and Wal-Mart found itself on the hook for the practices of the vendor.
Navigating the Landscape
When it comes to independent contractors, employers must be aware of all of the rules and regulations at the federal, state and local level. This is no easy task, as many states and local governments have their own specific requirements, and in many cases may be stricter than federal regulations. An organization’s HR department should be well-versed in the rules regarding who is and who is not an independent contractor, and when necessary, business leaders should work with an experienced professional if they believe their company could be vulnerable to audits or scrutiny by government agencies.