Are You Misclassifying Your Workers?

Hiring employees costs money, not only in the amount you’re paying them but also in taxes, fees, and time spent filling out the paperwork for the relevant government agencies.  Because of those headaches, it’s incredibly tempting to begin hiring workers as independent contractors.  If you are misclassifying your workers, you risk an audit by the IRS and your state unemployment agencies.  I’ve already discussed the factors considered by the IRS, but after helping a client through an audit by Nevada’s DETR (Department of Employment, Training and Rehabilitation), I thought I’d discuss their factors.

The employer must prove the following three conditions exist.  If you fail one, you fail them all and the person in question is an employee:

1.  The person has been and will continue to be free from control or direction over the performance of the services, both under his contract of service and in fact; AND

The more control you exert over the worker, the more likely that worker is an employee rather than an independent contractor.  Usually, if you, as the employer, dictate the end result but not the performance to reach the end result, you can pass this requirement.  The second part of the requirement means that having an independent contractor agreement is not enough.  If I followed the worker around all day I’d have to see that they are actually free from the employer’s direction or control over the performance.

2.  The service is either outside the usual course of the business for which the service is performed or that the service is performed outside of all the places of business of the enterprise for which the service is performed; AND

A good illustration of this requirement is a bakery that hires someone to design their website.  Because website design is outside the usual course of business for a bakery, that website designer would be an independent contractor.  Also, if the worker performs the work outside your place of business, it helps make the argument that the worker is an independent contractor.

3.  The service is performed in the course of an independently established trade, occupation, profession or business in which the person is customarily engaged, of the same nature as that involved in the contract of service.

If your worker has a full-time job doing the same types of work he or she is doing for you, it helps build the case for classifying them as an independent contractor.  This requirement is why you sometimes hear that it’s best if your independent contractors form their own LLCs or corporations and get their own business licenses.  This is only one of three requirements, so it might help, but it isn’t enough on its own.

If you’re reading this, chances are you’re ready to grow and expand your business – congratulations!  Having recently helped a client through a DETR audit, I can safely say it’s far better to follow the rules from the beginning than risk an audit and having to pay back taxes and penalties for misclassifying workers.  Remember, the burden of proving the worker is an independent contractor falls on the employer and a contract covering the requirements isn’t enough.