Tom Shaevsky, employee benefits attorney and shareholder at Butzel Long, with law offices in Ann Arbor, Bloomfield Hills, and Detroit, spoke with DBusiness Daily News about the importance of knowing the difference between classifying an individual as a permanent employee or as an independent contractor.
1. DDN: What should businesses know about working with independent contractors?
TS: A business and an individual might agree that the individual is an independent contractor, but the Internal Revenue Service may have a different perspective. If the IRS determines that person is really an employee, the business would be liable for unpaid employment taxes, for example, FICA (Federal Insurance Contributions Act). The business would be facing penalties for the under withholding of income taxes.
2. DDN: How does the IRS determine if someone is classified as an employee?
TS: The IRS has issued guidance delineating three categories of factors to determine whether an individual is an employee as opposed to an independent contractor. One is behavioral control. Does the business have the right to control how the individual does his or her job? Examples might be requiring or instructing the individual to perform work on premises or to use certain tools or equipment, which suggest that the person is more of an employee than an independent contractor.
3. DDN: What are the other factors to consider?
TS: (There’s also) financial control. If the business reimburses the individual for expenses, that might tend to suggest an employment relationship. If there is an opportunity for the individual to make a profit or loss that tends to suggest the person is an independent contractor. He or she may say, “I’ll do X as long as you pay me Y,” and then it’s up to the independent contractor to control his or her own costs in hopes of making the profit.
The final category is the type of relationship. For example, if the business is providing the individual with certain benefits, such as retirement benefits, health insurance, or vacation time, that would suggest the individual is an employee. If the business anticipates that the individual will be in an indefinite relationship with the business, (versus) utilizing his or her services for just one project, that would suggest he or she is an employee.
The bottom line is no one factor is determinative. It’s a balancing test.
4. DDN: Beyond tax penalties, what else could happen if an individual is misclassified as an independent contractor?
TS: They may be entitled to benefits under the business’ retirement programs as well as welfare programs, like health care insurance. (Their claim would be they) are entitled to those benefits on a retroactive basis.
5. DDN: How can employers prevent this situation?
TS: They could write their eligibility provision in the plan document to try to exclude someone who is subsequently reclassified as an employee. The document would say (something like): “Employees of the company are eligible to participate in this plan. An employee is someone classified by the company as an employee.” So if someone is subsequently reclassified as an employee, they’re not eligible to participate in the plan.