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contractors as opposed to employees can be well worth the money you spend in legal fees. You should also check with your insurance broker to make sure that any persons working for your business are covered by your general liability or automobile insurance, particularly if the workers are on the road for your business. Alternatively, you should demand proof of insurance from anyone working for you as an independent contractor. IRS publication 1779 provides an overview of IRS policies regarding this relationship. Exhibit 19.1
shows a summary of the characteristics of employment versus contractor relationships established by the IRS, often known as the “20-factor” test.1 The IRS
will make a determination for firms regarding the employment status of individuals. Firms can submit an IRS form SS-8 for this process. As noted at the end of this chapter, this is provided for informational purposes only and firms should consult an attorney regarding their specific situation.
Exhibit 19.2, summarizes a few of the related forms and publications available from the IRS regarding employment relationships.2
LAWS GOVERNING THE EMPLOYER-EMPLOYEE RELATIONSHIP.
Once
you make the decision to hire employees, a wide range of federal and state laws apply.
Minimum Wage and Maximum Hours—the Fair Labor Standards Act (FLSA) and State Law Requirements.
One of the most basic laws that applies to em-
ployees is the FLSA, the federal law that requires payment of a minimum wage and one and one-half an employee’s pay rate for overtime worked. The FLSA distinguishes between what the law calls “exempt” and “nonexempt”
employees. Exempt employees are excluded from the FLSA’s coverage. Exempt employees include certain executive, administrative, and professional employees. Each of these categories has its own specific definitions and requirements, including minimum salary requirements, so it is useful to consult with a lawyer to ensure that someone who you believe may be exempt from the FLSA’s requirements actually is exempt. Job titles alone are not determinative. In recent years, an increasing number of lawsuits have alleged that employees who should be classified as nonexempt have been misclassified as exempt and, thus, not given overtime pay. In such cases, the employer can be liable for a substantial amount of unpaid overtime and, in some cases, penalties for willful misconduct.
Employees who are nonexempt must be paid the federal minimum wage,
which is currently $5.15 per hour. There are a number of U.S. states which have established higher minimum wages. Exhibit 19.3 has a summary of current minimum wages in states that exceed the Federal minimum.3 As with any labor laws, these will change from time to time at the federal and state level and the firm should ensure that they are in compliance with the most recent applicable laws.
There are other exceptions to this rule as well. For example, food servers who earn tips can be paid a lower base wage rate as long as the tips they
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EMPLOYEE OR INDEPENDENT CONTRACTOR?
Whether someone who works for you is an employee or an independent contractor is an important question. The answer determines your liability to pay and withhold Federal income tax, social security and Medicare taxes, and Federal unemployment tax.
In general, someone who performs services for you is your employee if you can control what will be done and how it will be done.
The courts have considered many facts in deciding whether a worker is an independent contractor or an employee. These facts fall into three main categories: 1. Behavioral control: Facts that show whether the business has a right to direct and control. These include:
a. Instructions: An employee is generally told:
i. when, where, and how to work
ii. what tools or equipment to use
iii. what workers to hire or to assist with the work
iv. where to purchase supplies and services
v. what work must be performed by a specified individual
vi. what order or sequence to follow
b. Training–an employee may be trained to perform services in a particular manner.
2. Financial control: Facts that show whether the business has a right to control the business aspects of the worker’s job include:
a. The extent to which the worker has unreimbursed expenses
b. The extent of the worker’s investment
c. The extent to which the worker makes services available to the relevant market
d. How the business pays the worker
e. The extent to which the worker can realize a profit or loss
3. Type of relationship: Facts that show the type of relationship include: a. Written contracts describing the relationship the parties intended to create b. Whether the worker is provided with employee-type benefits
c. The permanency of the relationship
d. How integral the services are to the principal activity
For a worker who is considered your employee, you are responsible for:
• Withholding Federal income tax,
• Withholding and paying the employer social security and Medicare tax,
• Paying Federal unemployment tax (FUTA)
• Issuing Form W-2, Wage and Tax Statement, annually,
• Reporting wages on Form 941, Employer’s Quarterly Federal Tax Return.
Exhibit 19.1
IRS Guidelines for Establishing Employee and
Contactor Relationships
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The Back Office: Efficient Firm Operations
Tax Topic 762 Basic Information: To determine whether a worker is an independent contractor or an employee, you must examine the relationship between the worker and the business. All evidence of control and independence in this relationship should be considered. The facts that provide this evidence fall into three categories Behavioral Control, Financial Control, and the Type of Relationship itself.
Publication 1976, Section 530 Employment Tax Relief Requirements (PDF): Section 530
provides businesses with relief from Federal employment tax obligations if certain requirements are met.
IRS Internal Training: Employee/Independent Contractor (PDF): This manual provides you with the tools to make correct determinations of worker classifications. It discusses facts that may indicate the existence of an independent contractor or an employer-employee relationship. This training manual is a guide and is not legally binding. If you would like the IRS to make the determination of worker status, please file IRS Form SS-8.
Form SS-8 (PDF): Determination of Worker Status for Purposes of Federal Employment Taxes and Income Tax Withholding
Publication 15-A: The Employer’s Supplemental Tax Guide has detailed guidance including information for specific industries.
Publication 15-B: The Employer’s Tax Guide to Fringe Benefits supplements Circular E (Pub. 15), Employer’s Tax Guide, and Publication 15-A, Employer’s Supplemental Tax Guide. It contains specialized and detailed information on the employment tax treatment of fringe benefits.
Exhibit 19.2
receive reach a high enough level. Generally, if a nonexempt employee works more than 40 hours in a workweek, that employee must be paid overtime pay at a rate of not less than one and one-half times the regular rate of pay.
Discrimination and Related Legal Issues.
Federal and state laws broadly
prohibit discrimination on a variety of grounds in all aspects of the employment relationship, including the hiring, training, paying, promoting, disciplin-ing, and terminating of employees. A lawyer can help you navigate these important laws.
Under Title VII of the Civil Rights Act of 1964, it is illegal to discriminate against a person in the terms and conditions of his or her employment because of race, color, religion, sex, or national origin. The Age Discrimination in Employment Act (ADEA) makes it illegal to discriminate against a person because of age if he or she is over 40. The Equal Pay Act generally mandates that men and women be paid the same for the same work. The Americans with Disabilities Act (ADA) prohibits discrimination against a qualified
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MINIMUM
STATE
WAGE ($)
Oregon 7.05
California
6.75
Alaska
7.15
Illinois
5.50
Rhode Island
6.75
Massachusetts
6.75
Maine
6.25
Vermont 6.75
Washington
7.16
Hawaii 6.25
Delaware 6.15
Connecticut 7.10
Exhibit 19.3
Mimimum Wage
Standards by U.S. State
person with a disability and imposes on covered employers the duty to provide a “reasonable accommodation” to an employee’s or prospective employee’s disability. Under the Family and Medical Leave Act (FMLA), larger companies—that is, those with more than 50 employees—must honor the
need of employees to take leave from work to care for a newborn or to care for a family member ’s, or the employee’s own, serious health condition.
Still other perhaps less well-known but important federal laws exist. These laws include provisions of the Civil Rights Act of 1866, which prohibits racial discrimination in the making and enforcement of contracts (and thus applies to independent contractors); the Employee Retirement Income Security Act (ERISA), which regulates employee benefit plans and pension plans; the Occupational Health and Safety Act (OSHA), which imposes various health and safety standards on employers; and the Comprehensive Omnibus Budget Reconciliation Act of 1986 (COBRA), which requires employees to be notified of their right to continue health insurance coverage for up to 18 months after termination. Finally, if you intend to do business with the federal government or with someone who does business with the federal government, you should consider whether you will be required to adopt an affirmative action plan and