Practice Management

Independent Contractors

A number of law firms choose to classify part-time employees as Independent Contractors because it?s easier than adding them to payroll, or dealing with tax deductions, workers compensation, and benefit decisions based on part-time or erratic hours of service.   But what are the risks involved?

Some of the risks depend on whether the employee is properly categorized or not.  A number of years ago an internal IRS enforcement memo issued instructions to target law firms who categorized attorneys as Independent Contractors.  The IRS ?red flag? was easy enough to spot because a firm has to submit a 1099 at year end to each contractor, and send a copy to the IRS.

Based on that memo, even if the firm?s classification was correct, the risk was an increased likelihood of audit.  And as we all know, audits are expensive propositions.  Even if you emerge with no violations, penalty, or interest, it will likely cost thousands of dollars in accounting fees, and a whole lot more in emotional distress.

If you have misclassified true employees as independent contractors, however, the penalties and interest mount quickly.  Another unanticipated consequence is that misclassification can jeopardize tax-deferred benefit plans which should have covered those employees.

A number of years ago Microsoft paid a huge sum for having misclassified part-time software programmers as Independent Contractors ? some who had put in one or more years of service.  They were also entitled to back benefits.

Federal Express is currently embroiled in a battle with 19 states over their decision to classify delivery drivers as independent contractors, rather than employees. They may have to pay over $319 million in penalties.

Defining the Independent Contractor isn?t always easy, even if it may seem obvious on the surface.  On the Department of Labor Fair Labor Standards Act Advisor on Independent Contractors, they state:

?The Supreme Court has said that there is no definition that solves all problems relating to the employer-employee relationship under the Fair Labor Standards Act (FLSA). The Court has also said that determination of the relation cannot be based on isolated factors or upon a single characteristic, but depends upon the circumstances of the whole activity. The goal of the analysis is to determine the underlying economic reality of the situation and whether the individual is economically dependent on the supposed employer. In general, an employee, as distinguished from an independent contractor who is engaged in a business of his own, is one who “follows the usual path of an employee” and is dependent on the business that he serves.?

Slightly better information is found on the IRS web site.  There?s also some pretty good detailed discussion in a post on The Human Resources Blog.

If you aren?t sure, consult with a qualified employment law attorney before a new relationship is established.  It?s much cheaper than paying interest and penalties for a misclassification.

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Full post as published by Law Practice Management on November 17, 2009 (boomark / email).