More small businesses turning to ICs — and why it’s a potentially dangerous move
The trend seems clear: Small companies are turning more and more to independent contractors.
A recent SurePayroll study says that 22% of small business owners are more likely to hire independent contractors than full-time workers in the coming months.
Why? Of those who said they’re planning on going the IC route, about half said it’s just simpler to hire somebody to perform a specific task than to bring on a full time employee, SurePayroll president Michael Alter wrote recently on Inc.com.
What’s more, Alter said, using an IC means not having to worry about payroll taxes and benefits, which saves businesses money. At the same time, they’re able to take advantage of the specialized skills these contractors offer. Thirty-six percent of small business owners said reduced tax and benefits costs was the top reason they hire independent contractors.
And (surprise!) healthcare reform comes into the picture, too. Almost one in four (23%) of the owners leaning toward ICs said they were doing so to keep their full-time workforces under the magic number of 50 — where all those complicated Affordable Care Act rules and regs kick in.
Stakes get higher
The advantages of using independent contractors aren’t hard to see. But the tactic carries some fairly serious legal risk.
Why? The ACA will now require employers to put even more effort into making sure workers are classified correctly.
Prior to the passage of Obamacare, difficult economic conditions and tighter budgets sparked many employers to start using more independent contractors. Unfortunately, some of those employers overstepped their bounds and misclassified individuals who should’ve been employees as independent contractors.
As a result, the IRS and DOL started an all-out war to hunt down employers who misclassify workers and slap them with large fines, and back pay and tax penalties.
The added incentive to classify workers as independent contractors combined with increased enforcement by the IRS and DOL is a dangerous cocktail for employers.
The inherent danger in misclassifying employees as independent contractors grows exponentially when the clock strikes midnight on Jan. 1, 2015 — that’s when enforcement of the shared responsibility requirement will kick in.
At that point, the penalty for misclassification could go far beyond paying the now standard-fare IRS and DOL fines and enter the zone of uber-expensive Obamacare fines.
What if you were audited?
The ACA’s shared responsibility requirement states that large employers (those with 50 or more full-time equivalent employees) must offer its employees “minimum essential coverage.”
If a large employer fails to offer minimum essential coverage to at least one full-time employee — and that employee receives a federal premium tax credit or cost-sharing reduction to purchase health insurance on an exchange — then the employer must pay a $2,000 per-employee penalty for every full-time equivalent employee on staff (minus the first 30 employees).
So how would this impact an employer guilty of misclassification?
Say your company employs 45 full-time employees. It considers itself a small employer under Obamacare and therefore isn’t subject to its shared responsibility requirement. Therefore, it doesn’t offer health coverage to its workforce.
But your company also uses 35 independent contractors. If an audit reveals those contractors are actually full-time employees, your company will become a large employer subject to Obamacare’s shared responsibility penalty — which will be quite expensive.
The feds will say you have 80 full-time employees who aren’t being offered health insurance. It’ll then subtract the first 30 employees from the number, giving you a total of 50 — for each of whom you’ll have to pay the $2,000 penalty.
That’s $100,000 per year.
That penalty, however, can be broken up into one-month increments until your company comes into compliance with the ACA. So the penalty is actually $8,333 per month — in addition to the other fines, back pay and tax penalties the feds are likely to slap you with.
Rules of the IC road
So how can companies protect themselves from classification audits and/or claims of employee misclassification?
First and foremost, when classifying workers, follow the IRS’ three-point checklist for determining a worker’s classification:
- Behavioral control. The IRS says if your company has the right to control or direct not just what work needs to be completed, but how it gets completed, the worker is most likely an employee.
- Financial control. There are two financial signs that can indicate whether a worker is an independent contractor: The person is most likely an independent contractor if he or she A) has a significant personal investment in the work, or B) can incur a profit or a loss.
- Type of relationship. The IRS also looks at how the worker and company perceive the relationship. For example, if the person receives benefits — like insurance, a pension or paid leave — that’s a giveaway the person’s an employee.
There are also several telltale signs independent contractors should actually be employees:
- They don’t have a business license
- They don’t have their own place of business
- They lack their own equipment
- They are solely dependent on your business, or
- They perform the same work as those classified as employees.
If any of these conditions apply to independent contractors working for you, it’s time to revisit their classification.
In addition, for the feds to consider someone a bona fide independent contractor, the workers must be in business for themselves, have the power to use their own employees or subcontractors and they should NOT be working full-time for your company.
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