Hawaii employers continue to take a risk when they classify someone performing services for them as an independent contractor instead of an employee. Because employers owe contractors far fewer obligations than employees, employers risk each of the following if a court determines that a misclassification occurred:
- Unpaid overtime
- Unpaid taxes
- Unemployment benefits
- A discrimination claim, or claims under other laws that protect employees but not contractors
In determining whether a worker is an employee or an independent contractor, the IRS compares the degree of control exerted by the company to the degree of independence retained by the individual. Generally, the IRS examines this relationship in three ways:
- Behavioral: Does the company control or have the right to control what the worker does and how the worker does his or her job?
- Financial: Are the business aspects of the worker’s job controlled by the payer?
- 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?
If you are considering classifying someone performing services for you as an independent contractor, your answers to these three questions will determine whether that individual is a bona fide contractor, or instead, is an employee.
When in doubt, err on the side of caution. The government applies these tests aggressively to find employee status whenever it can. You should too, and the risks are too high to make a mistake.
- Hire a Contractor or an Employee? Independent contractors and employees are not the same, and it’s important to understand the difference. Knowing this distinction will help you determine what your first hiring move will be and affect how you withhold a variety of taxes and avoid costly legal consequences.
- What Is the Difference?
An Independent Contractor:
- Operates under a business name
- Has his/ her own employees
- Maintains a separate business checking account
- Advertises his/ her business’ services
- Invoices for work completed
- Has more than one client
- Has own tools and sets own hours
- Keeps business records
- Performs duties dictated or controlled by others
- Is given training for work to be done
- Works for only one employer
Many small businesses rely on independent contractors for their staffing needs. There are many benefits to using contractors over hiring employees:
- Savings in labor costs
- Reduced liability
- Flexibility in hiring and firing
- Why Does It Matter? Misclassification of an individual as an independent contractor may have a number of costly legal consequences.
If your independent contractor is discovered to meet the legal definition of an employee, you may be required to:
- Reimburse them for wages you should have paid them under the Fair Labor Standards Act, including overtime and minimum wage
- Pay back taxes and penalties for federal and state income taxes, Social Security, Medicare and Unemployment Insurance
- Pay any misclassified injured employees workers’ compensation benefits
- Provide employee benefits, including health insurance, retirement, etc.
- There is no single test for determining if an individual is an independent contractor or an employee under the Fair Labor Standards Act. However, the following guidelines should be taken into account:
- The extent to which the services rendered are an integral part of the principal’s business
- The permanency of the relationship
- The amount of the alleged contractor’s investment in facilities and equipment
- The nature and degree of control by the principal
- The alleged contractor’s opportunities for profit and loss
- The amount of initiative, judgment, or foresight in open market competition with others that is required for the success of the claimed independent contractor
- The degree of independent business organization and operation