Independent Contractors vs. Employees
If you’re a business owner in New Jersey or New York, you need to know how to protect yourself and your business by understanding the differences between having an employee vs. having an independent contractor. A little background here… A business can classify its workers in one of two ways, either employees or independent contractors. Employees are very expensive because the business needs to pay the wages of the worker but also handle tax withholdings, payroll taxes, employment taxes, and further provide benefits to the employee. Generally, businesses don’t need to do any of that for an independent contractor. Overall, businesses prefer having independent contractors while the IRS and state tax agencies much prefer that a worker is classified as an employee and will pursue any businesses that misclassify their employees as independent contractors. Where is the legal line? It is very vague, but the overall issue is about control. The more control that a business has over the worker, the more likely that worker is an employee, and the IRS has a three-prong test to determine whether a worker is an employee or independent contractor: Behavioral Control, Financial Control, and Relationship Control.
Behavioral Control:
• Amount of Instructions: More instructions = Worker is Employee.
• Detail of Instruction: More details = Employee.
• Systems of Evaluation: More measuring the details of how worker works = Employee.
• Training: More training about procedures and methods = Employee.
Additionally, where does the worker work? At the company’s office? If so, it looks a lot more like an employee versus contractor.
Financial Control:
• Expenses reimbursed? If yes more likely worker = Employee.
• Risk of profit or loss? If worker has little risk more likely = Employee.
• Can worker have other clients? If no, more likely worker = Employee.
• How paid? If regular wage worker likely = Employee, if flat fee likely = IC.
Who is providing the tools or hardware that the worker uses to complete their work? If the business provides same, then it appears that worker is an employee vs. independent contractor. Are there any risks of lost profits? The less risk, the more the worker appears to be an employee. Can a worker have other clients? If they cannot have other clients, it appears the worker is an employee. How is the worker paid? If paid a flat fee, it appears the worker is an independent contractor. What kind of activities does the worker actually do?
Relationship Control: The type of relationship depends upon how the worker and business perceive their interaction with one another.
• Key activity? If yes, likely worker = Employee.
• Worker Benefits (insurance, vacation)? If yes more likely worker = Employee.
• Permanency? If relationship continue indefinitely = Employee, set time = IC.
• Written Agreement? If no likely worker = Employee?
Are there benefits for the worker (insurance, vacation)? Is there a permanent relationship or is it more based on a set agreed upon term? If there’s a defined term, the more the worker appears to be an independent contractor. Finally, is there a written independent contractor agreement?
How do problems arise for companies? Let me tell you a story about my client named Patrick. Patrick owned a general contracting company specializing luxury homes, and had a worker named Jason. Patrick and Jason had a verbal agreement that Jason was an independent contractor and not an employee of Packer. Unfortunately, there was a dispute between the two regarding the quality of Jason’s work and payment to Jason. Jason decided to report Patrick to the New Jersey Department of Labor (as well the NJ Division of Taxation), claiming that he did not receive his benefits as an employee of Patrick. Jason’s complaint triggered an investigation by both the New Jersey Department of Taxation and Department of Labor, which almost resulted in Patrick having to pay thousands of dollars in fines back taxes and interest on his back taxes (not to mention the emotional cost). The lesson here is that if you misclassify employees as independent contractors it can be very costly for you.
Though it is not a final determining factor, it definitely helps you as a business owner if you have a written independent contractor agreement with your worker specifically defining the relationship that there an independent contractor. The screenshots are of a simple New Jersey independent contractor agreement for marketing services.
The independent contractor agreement is dated the 19th of May 2020 and is between Michael Herring and Associates. Section 1.1: As we previously discussed, it is best to have a defined term, and in this case the term of this independent contractor agreement is 18 months. (This obviously strengthens the argument that worker is an independent contractor and not an employee.)
Section 1.3: This is very important paragraph that specifies the independent contractor is acting as an independent contractor not an employee.
In section 2, the compensation is identified, and in this case the independent contractor receives the net profit for selling a software program called “Docuserve”.
Section 2.2, Withholding Other Benefits: This is an important section because it specifically identifies the fact that the business does not have the responsibility to pay or make any contribution for Social Security, local, state, federal tax, and all of those requirements are the duty of the independent contractor.
Ownership of IP you want to make sure as a business owner that you retain all ownership interest in the intellectual property of anything that’s produced by the independent contract.
Section 6, Indemnification: Indemnification is a very complicated topic and it is a section that is highly negotiated by attorneys. In larger deals, I’ve seen indemnification sections that are eight single spaced pages in length. Indemnification is a topic that would require a 3+ hour long video to cover, but for the purpose of this independent contractor agreement, just know that indemnification is compensation for damages or harm suffered by the other party and how the offending party will be required to pay for those damages.
Section 7 Non-Solicitation: Many clients want to me to include language that prevents the worker form working for another company. However, this is often unwise… If you prevent the worker from working for another company the government can argue that the worker is an employee and not an independent contractor. Therefore, what a business can do is have a non-solicitation section in the agreement. In the agreement at hand, during the term of the agreement and for one year after, the independent contractor will not solicit or take away or interfere with the business of the company.
Section 8, Miscellaneous Provisions: In Section 8.4 the parties can select where they want any dispute to be heard, and in this case the parties have agreed to Essex County, New Jersey. Jury waiver: This is something that you may want to include because in the event of any dispute a jury trial can be very expensive. Lawyers will be required to go through the time and effort of selecting jury and then trying the case with the Jury. Often, it is advisable to waive that jury and just have the matter heard and decided solely by the judge.
In conclusion if you want to retain a worker and ensure that worker is classified as an independent contractor, make sure you keep the idea of control in mind. Further, make sure you have a written independent contractor agreement, and speak with a lawyer.