Technology companies receive services from a variety of individuals and often use consultants, either for marketing advice, for software development or for other discreet tasks. It’s important to be sure the consultants are properly classified as such (in which case, they are “independent contractors”) and that they should not be classified as employees. If you fail to make the correct classification and treat employees as independent contractors, your company could be liable for a wide variety of claims, including employee benefits, overtime pay, workers’ compensation insurance, back taxes, interest and penalties. Moreover, in some cases, this liability may extend to you personally and not just to your company.
The IRS and the Department of Labor have each developed a list of factors that play a part in determining whether a “consultant” is an independent contractor or an employee. Based on whether enough of these factors are present, a determination is made on a case-by-case basis. Some of the factors are:
- Independent contractors do not have to follow specific instructions about how to accomplish the task they are charged with. They only have to deliver the result.
- Independent contractors don’t receive training from the company.
- Independent contractors may hire employees or subcontractors to complete the job.
- Independent contractors can set their own hours and perform their duties at any location; or, if the independent contractor works at the company’s office, he or she is not under the supervision and control of the company.
- Independent contractors typically engage in projects other than the one they are engaged in for your company.
Typically, a company would prefer to classify a worker as an independent contractor rather than an employee. There are a number of reasons for this, including:
- With an independent contractor, a company is not required to withhold income taxes, withhold and pay in Social Security and Medicare taxes, or pay unemployment tax for employees.
- Independent contractors are not entitled to “time and a half” for overtime as certain employees are.
- The company does not provide an independent contractor with any benefits, such as health insurance, vacation, etc.
- Independent contractors typically use their own facilities and equipment, making it less expensive for the company to complete a specific project.
There are also disadvantages to hiring someone as an independent contractor rather than as an employee, including the following:
- A company does not have control over the manner in which the work is performed – the independent contractor simply has to complete the designated project.
- Independent contractors are free to change their rates as they see fit on future projects or to decline to take on future projects.
- Independent contractors will not take on a variety of additional duties and many small companies need people who can “wear many hats.”
- Independent contractors do not have a “duty of loyalty” to the company, as an employee does. This duty impacts a person’s overall behavior vis-à-vis the company and its business and can be very important to the company’s success.
There is a significant risk to misclassifying employees as independent contractors. If the mistake is discovered, the company will be required to pay back taxes and interest and, in many cases, will also be required to pay penalties. Moreover, under certain circumstances, the executives of the company will be personally liable for these taxes, penalties and interest.