Independent Contractor vs. Employer; Identifying the correct classification Version 3A February 15, 2013 Disclaimer: This guide is solely intended to be a free advisory source. All the information contained in this guide is based on the interpretations of Interim HR Consulting s research and experience. The recommendations are intended to assist in the avoidance of misclassifying contractors. Employers should always seek legal advice when creating a strategy of avoidance.
The Guidelines Are Foggy At Best The Illinois Department of Employment Security has been aggressively seeking audits of companies which have been utilizing independent contractors. It is our hope that this document will give you a better understanding as to how to protect yourself from an audit by the IDES. One of the first things you should know about the guidelines concerning independent contractors in the state of Illinois is; unlike the federal guidelines there is no published checklist detailing when a person is considered a contractor versus when the Illinois Department of Employment Security determines that individual to be an employee. Having What is an independent contractor? We can look at three different places when answering this question. A sometimes difficult status to determine, what makes an independent contractor has been outlined by common law principles, the fair labor standards act, and finally the decisions of some courts. The IRS in many states has adopted common-law principles to define independent contractor. These rules focus primarily on the level of control and employer has over a service or product, meaning, whether or not the employer actually defines what is being done and how it will be accomplished. Common-law principles further define independent contractor status by method of compensation. If a person is on an employer s payroll and receives a steady paycheck, clearly that person is an employee rather than an independent contractor, who likely receives payment in a different manner. Other considerations when identifying someone as an independent contractor include: 1. if the worker supplies his or her own equipment, cereals and tools 2. if all necessary materials are not supplied by the employer 3. if the worker can be discharged at any time and can choose whether or not to come to work without fear of losing employment 4. if the worker controls the hours of employment thus indicating that they are acting as an independent contractor 5. whether the work is temporary or permanent
Again the nature of the work will help define the relationship. When work is considered key to the company s business, it is more likely that the person is an employee. On the other hand, work that is temporary and not open ended may imply independent contractor status. In an attempt to interpret provisions of the Fair Labor Standards Act and discern between employees and independent contractor status, some courts and federal agencies have come up with the economic realities test. It looks at the dependence of the worker at the business for which he or she works. If a person gains a large portion of their salary on that business, chances are that person qualifies as an employee. The test also factors in such things as level of skill, nature of work, intent of the parties in payment of Social Security taxes and benefits. Outside the Labor Standards Act, courts asked the following questions to determine work relationship in addition to both an academic and agency test: 1. What is the degree of control over work and who exercises that control? 2. What is each party s level of loss in the relationship? 3. Who paid for materials, supplies and or equipment? 4. What types of skills are required for work? 5. Is there a degree of performance? 6. Is the worker an integral part of the business? These courts also use the right to control test. When the hiring party controls the way work is carried out in a product is delivered, the relationship between the parties is employer/employee. If employer does not have the authority over how a party accomplishes his or her work but simply give requests an outline, the relationship between the parties is that of hiring party/independent contractor. Employer Tax Liability An employer s tax liabilities determined by the workers employment status. When a worker is employee, employers must pay state and federal unemployment tax, so security tax and workers compensation/disability premiums to a state insurance fund. When a worker is independent contractor, the hiring party is not required to make any of these payments. Should employers incorrectly defined a worker as an independent contractor; they may find themselves liable for past taxes including FICA and federal unemployment tax. Safe harbors which allow employers to use the independent contractor status and avoid penalties include:
prior practice of treating similar employees as independent contractors and the existence of a prior IRS audit which no taxes are required to be paid. The IDES Perspective Certain factors will determine a worker as an independent contractor in every case: not relying on the business as the sole source of income, working at his or her own pace as defined by an agreement, being ineligible for employer-provided benefits and retaining a degree of control and independence. While the independent contractor is his or her own boss, work stays within the definitions of an oral written contract and adheres to certain requirements. An employee, on the other hand, relies in the business for steady income, gives up elements of control and independence, and is eligible for certain benefits and works within constraints of workplace. THE ILLINOIS DEPARTMENT OF EMPLOYMENT SECURITY: Independent contractor guideline under section 212 of the Illinois Unemployment Insurance Act, states service performed by an individual for an employing unit, whether or not such individual employs others in connection with the performance of such services, shall be deemed employment unless and until it is proven in any proceeding where such issue is involved that: 1. Such individual has been and will continue to be free from control or direction over the performance of such services 2. Such service is either outside the usual course of business for which such services performed or that such service is preformed outside of all the places of business of the enterprise for which the service is performed 3. Such individual is engaged in an independently establish trade, occupation, profession, or business If the business can t demonstrate each of these three requirements, the IDES will likely declare the worker to be an employee. This finding will result in an assessment for back amounts owed, interest, and could include penalties. te: Because employers are also required to withhold Income Taxes and pay Social Security and Medicare Taxes employees, misclassification can also raise problems with the IRS.
The Answer You ve Been Waiting For Utilizing a temporary HR services firm, such as Interim HR Consulting Corp, will protect you and your company. The obvious reasons to utilize human resource consulting firms are reasons such as: full liability insurance, prescreened applicants, cost controls, project supervision as well as establishing clear third-party contractor relationships. Human resource consulting firms create a protective layer between the clients that is seeking temporary or long-term assistance, without creating an employee/employer relationship. The following is a list of items that clearly define how the client and contractor relationship through a human resource consulting firm is clearly established. 1. Payroll- One of the main determining factors on both the federal and state level pertains to the contractors pay. If a company directly pays the individual than under the state and federal guidelines the individual is more than likely to be categorized as an employee of the business. This is completely eliminated by having a third-party human resource consulting firm provide the payroll services. This action alone provides one of the best defenses for a client when having to define the difference between the individual being a contractor or an employee. 2. HR Consulting Expenses- One of the clearest indications that an independent contractor working at a client s location is not employee is the fact that the HR Consulting firms have established markups covering their services and expenses. The money paid to consulting firm establishes a clear set employer employee relationship between the third-party human resource provider and the contractor working on site. In this example it is very clear based on the pay and the third-party contribution that the consultant is an employee of the contracting firm. 3. Contractual Agreements- The contractual agreements between the consultants and the Consulting firms is another solid piece of evidence for any client. Typically this agreement stipulates that the contractor works for third-party provider and therefore is not entitled to any employee level benefits or postemployment allowances for the client he/she is assigned to work with. It is essential that clients make sure they evaluate the contract between the HR Consulting firm and the consultant to verify that they have created a contractual agreement that clearly stipulates the consultant has no claims against the client, where they will be performing the task related to the project. 4. Independently Establish Trade- In order to protect themselves from the same employee/employer relationship rules HR Consulting firms will require any individual
whom desires to be listed as an independent contractor (1099 status) to provide documentation supporting incorporation. This documentation should be listed in the contract between the service provider and the consultant. This is yet another reason all clients should ask for a copy of the consultants agreement with the service provider. 5. Employee Consultant- Lately third-party providers are choosing to use employee status or temporary seasonal help status in place of allowing independent contractors for some projects. This further insulates companies from having to defend the question as to whether or not a contractor is in fact employee. This is especially important for a client when they are considering bringing out a consultant performing a task that is not directly an initiative or project related task. If the consultant is nearing the activities of other dayto-day employees the client request for third-party provider have the consultant listed as a W-2 employee during that duration. 6. Services Location- Another factor in determining whether or not consultant is an employee or contractor deals directly with the question services are performed outside of all places of business of the enterprise for which such services are performed. By using a third-party vendor the official place of business for the consultant would be listed as the headquarter location of that vendor, not the clients location. Conclusion. It is no surprise that government agencies prefer to have companies liable for taxes associated with contractors (or employees), since collecting from individuals is significantly more difficult. In light of this, declaring someone as a contractor proves difficult, especially if they are working on a direct basis for your company. The proof of contractor status process can be clearly supported by the use of a third-party vendor such as Interim HR Consulting. Using a third-party has helped our customers protect themselves from unnecessary attention by state and federal agencies. Opening your company up to an audit will cost both time and money, plus it is guaranteed to be frustrating to say the least. Utilizing a third-party vendor should, if done properly, can eliminate the prospects of your company being audited for using an independent contractor.
BONUS PAGE RECENT IDES WORK RELATIONSHIP QUESTIONEER Illinois Department of Employment Security Worker Relationship Questionnaire This information is required to determine whether a worker is an employee or an independent contractor for the purposes of the Illinois Unemployment Insurance Act. This form should be completed for one individual who is representative of the class of workers whose status is in question. A separate form must be completed for more than ore class of workers, or if the facts are materially different within the same class of workers. For purposes of this document, Firm represents the individual, corporation, partnership, association, or other type of organization for whom services were performed. Worker represents the individual who is performing the services in question. 1. Identification 1.1 Owner, Partners, or Corporation 1.1.1 Name: 1.1.2 Trade Name: 1.1.3 Address of Firm: 1.1.4 City, State, Zip: 1.1.5 Telephone Number: 1.1.6 U.I. Account Number: 1.1.7 FEIN: 1.1.8 Type of Firm: Individual Corporation S Corporation Partnership
LLC Other Specify Other 1.2 Representative Worker 1.2.1 Name: 1.2.2 SSN: 1.2.3 Address: 1.2.4 City, State, Zip: 1.2.5 Number of persons performing the same type of work as the Representative Worker: 1.2.6 Is the Representative Worker considered as "Sales Personnel"? (If, Section 5, Questions for Sales Personnel, must also be completed.) In the following sections, all items must be answered. If you need more space attach another sheet. 2. Course of Business & Place Where Services Performed 2.1 Describe the nature of the firm's business: 2.2 Give a complete description of the work done by the worker: 2.3 Is the type of service performed by the worker the same type of service provided by the firm? In the following sections, all items must be answered. If you need more space attach another sheet. 3. Extent of Independent Status 3.1 Under which business name does the worker perform services for the firm? Firm Worker 3.1.1 Comments: 3.2 Does the worker represent himself to the public as being in business to perform the same or similar services?
Unknown 3.2.1 If, explain how: 3.3 Does the worker have a shop/office of his/her own separate from the firm? Unknown 3.3.1 If, explain where: 3.4 Can the firm discharge the worker at any time? 3.5 How did the firm learn of the worker's services? 3.6 Did the firm advertise the position opening? 3.7 Can the worker terminate his or her services at any time? 3.8 Can the worker incur a loss in the performance of the services for the firm? 3.8.1 Explain: 3.9 Does the worker have helpers? 3.9.1 Who pays the helpers? Firm Worker 3.9.2 What services do the helpers perform?
3.10 Does the worker advertise or maintain a business listing in the telephone directory, trade journals, or have a website? 3.10.1 If yes, specify Unknown 3.11 If a license is necessary to do the work, is the license obtained by and under the name of the worker? 3.12 Is the worker given training by the firm? Unknown 3.12.1 What kind? 3.13 Does the firm represent the worker as an employee? In the following sections, all items must be answered. If you need more space attach another sheet. 4. Direction and Control 4.1 Does the firm issue assignments or schedule work, set quotas or time requirements? 4.2 Does the firm have the right to change the method used by the worker, or direct him on how to do the work? 4.3 Does the firm require the worker to report to a specific location? 4.3.1 If yes, what is the location? (Office, warehouse, etc.) 4.4 Does the worker furnish a record of his time to the firm?
4.4.1 Please attach copies of report forms used for reporting to the firm. 4.5 Does the firm engage the worker for: A particular job Permanently Indefinite period Specified period 4.6 Does the firm bond the worker? 4.7 Does the firm carry Workers' Compensation Insurance on the worker? 4.8 How does the firm report the worker s income to the Internal Revenue Service? W-2 Form 1099 Does not report 4.9 Does the firm reimburse the worker for expenses incurred? 4.10 Does the firm furnish the worker with materials, tools, supplies or equipment? 4.10.1 If yes, please explain. 4.11 Was the work done under a written contract? 4.11.1 If yes, please attach a copy of an actual contract signed by the firm and the worker. Copy attached? 4.12 Interview 4.12.1 Name and title of person interviewed: