Independent Contractor Problems May Arise With Current Employees

by Michael Haberman on April 27, 2011 · 1 comment

Independent contractors that have been improperly classified as such can cause alot of tax and FLSA issues. I have written about the use of IC’s several times. You can find these posts here and here and here. One issue regarding independent contractors that I have not written about is the use of current employees to perform work outside their normal job after hours. Often this is work that would normally be performed by another company.

I had a client who used employees to perform cleaning that an outside firm had been doing. They thought they were being good to the employees by giving them a chance to earn some extra $$$. The problem was they were paying these people in cash, based upon their normal hourly wage. They were not really tracking the time. All of this was a big problem, both under the FLSA and the IRS’ rules on independent contractors. Let’s review what these might be.

First, with independent contractors the rules are as follows:

  1. Behavioral: Does the company control or have the right to control what the worker does and how the worker does his or her job?
  2. Financial: Are the business aspects of the worker’s job controlled by the payer? (these include
    things like how worker is paid, whether expenses are reimbursed, who provides tools/supplies, etc.)
  3. Type of Relationship: Are there written contracts or employee type benefits (i.e. pension plan, insurance, vacation pay, etc.)? Will the relationship continue and is the work performed a key aspect of the business? (Taken from the IRS website)

So in my example above it is apparent that the employees performing the cleaning were NOT independent contractors. They were paid their normal hourly wage, they used company equipment, and they were told what to clean and when. A clear violation of the rules creating tax problems and wage and hour problems as I will discuss below. How would these people meet the IC test. First, they would have to have clocked out of their “day” job. If they were organized as a cleaning company that charged a fee for their services and they offered those services to other companies as well and they used their own cleaning equipment then they might meet the IC standards. A services contract would help as well. Using an employee to perform IC work might raise a RED FLAG but having these safeguards in place may remove problems.

What FLSA wage and hour issues were caused by these employees being improperly misclassified as IC’s? Here is the list:

  • Not tracking the time they worked, thus missing hours worked that should be used to calculate overtime. And since they were working 40 hours a week already those hours spent cleaning should have been paid out as overtime.
  • Since the hours were not paid as overtime the employees were due back pay for the last two years, if they had been working the cleaning job that long.
  • There were also tax issues involved, as the company nor the employee had paid any income tax on the cash payments.

(BTW, there is a way to structure an employee doing two different jobs at two different pay rates, but that is a topic for another time if anyone is interested.)

So, as you can see the use of independent contractors is not all about using people from the outside. Use of current employees to go extra stuff as an IC can cause problems too. It is critical you understand these rules in order to avoid tax and back wage issues.

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