Using Contractors: Proceed with Caution


By Frank J. Godfrey III

FreelancerOrEmployee_webBusiness owners often consider using independent contractors in place of employees. This makes business sense because the proper use of independent contractors produces financial benefits for business owners.

Unfortunately, when business owners misclassify independent contractors, the financial consequences can be significant. Penalties for misclassification include:For example, there are savings in payroll taxes and employment benefits. Furthermore, wage and hour laws are not applicable, negating the need to track overtime, for example.

– Reimbursing the contractor for employment benefits you offer employees. These may include medical insurance, 401(k) contributions, paid vacation and sick days, etc.

– Paying the government back payroll taxes for each misclassification during each tax period including unemployment insurance taxes, workers compensation insurance, Social Security and Medicare taxes, etc.

– Providing the contractor back overtime pay

– Paying civil fines to government agencies for violating laws regulating employee benefits, including the Family Medical Leave Act, Oregon Family Leave Act

– Restructuring costs to ensure proper compliance for the present and future workforce.

– The stakes are high and for the last several years both state and federal agencies have stepped up enforcement of independent contractor misclassification. These state and federal agencies include the Bureau of Labor and Industries, the Oregon Revenue Department, the Equal Employment Opportunity Commission, the US Department of Labor, and the Internal Revenue Service. This enforcement trend will continue into the foreseeable future.

It is important to properly classify independent contractors given the above consequences. However, proper classification is challenging. Use of independent contractor agreements can be helpful, but words alone are not enough to shield business owners from the costly consequences of misclassification. State and federal agencies will consider the facts of the relationship to determine classification. The agencies’ tests focus on whether the worker is free from the business owner’s direction and control and whether the worker is independent of the business to which it is providing services. For example, an independent contractor:

– does business as a corporation, limited liability company or under an assumed business name,

– has an office (preferably outside of their home), and

– provides their own insurance, licenses and permits.

This list is not exhaustive; there are other determinative factors considered by courts or state and federal agencies when adjudicating employment status.

To further complicate matters, each agency may use a different legal test to determine whether there is an actual employment relationship. For example, the Bureau of Labor and Industries uses the “economic reality

test” to determine proper classification in a wage and hour dispute and the “right to control test” to determine classification in a civil rights dispute. And as always, the facts of each situation are carefully considered and the business owner bears the burden to prove proper classification.

Proper use of independent contractors requires consideration and planning. Business owners contemplating the use of independent contractors should proceed with caution and seek legal advice to limit exposure to liability.