Employers must follow strict rules for independent contractors

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Government is cracking down on those that don't

Economists were generally pleased by December's employment report showing strong job growth. But in the new economy, many of the jobs created since the financial crisis have been part time and “contract” jobs.

In fact, the growing role of contract workers, or freelancers, in the labor market has gone largely unexamined. Contract workers are paid by the job, usually at a rate less than an employee, and they receive no benefits.

There is nothing wrong with hiring independent contractors instead of employees and plenty of workers are happy to operate as freelancers. But businesses and organizations that hire independent contractors must follow strict rules. If workers are contractors, they can't be treated as employees, saddled with all the disadvantages of an employee and none of the benefits.

Knowing the difference

If you are asked to work as an independent contractor, it will be helpful for you to know the difference between a contractor and employee.

First, there are different kinds of independent contractors. Some are business owners. They might own a small company that provides IT or other services to other businesses.

Some are professionals. Doctors, dentists and lawyers are usually independent contractors. Their roles are pretty well defined.

Where things get tricky is when a business or organization assigns duties traditionally performed by an employee to a freelancer or independent contractor. Sometimes called “contract employees,” these workers are paid a lump sum with no taxes withheld.

With employees the employer withholds federal and state taxes and Social Security and Medicare taxes, contributing half of the employee's Social Security and Medicare tax. An independent contractor must pay the full amount – the half normally paid by an employee and the half paid by the employer. Contract workers are not eligible for unemployment or workman's comp, as employees are.

Trade off

For that downside, the contract employee enjoys a certain trade-off – freedom. They are assigned work to do and given a deadline. When and how they do it, however, is up to them. The Internal Revenue Service (IRS) is quite clear about this.

“You are not an independent contractor if you perform services that can be controlled by an employer -- what will be done and how it will be done, the IRS rule says. “This applies even if you are given freedom of action. What matters is that the employer has the legal right to control the details of how the services are performed.”

Control is the key word here. And many employers increasingly are requiring independent contractors to behave like employees. Consider the text of this Washington, D.C., help-wanted ad we found on Craigslist that appears to violate both the spirit and letter of the IRS independent contractor rule:

This work requires a prompt 8:00 a.m. start time in the Dupont Circle neighborhood and a 40-hour per week commitment. Hourly wage will be commensurate with experience. We are hiring on a contract basis only (1099), with no benefits offered. Initial contract will be for 60 days. No telecommuting.

Requiring the contractor to show up at a certain location at an exact time 40 hours a week makes them an employee, and a full-time one to boot. That, according to the IRS, is controlling the details of how the work is done.

Stepping up enforcement

The federal government is helping states step up enforcement of independent contractor rules. Last September the U.S. Labor Department awarded $10,225,183 to 19 states investigate the misclassification of workers.

"This is one of many actions the department is taking to help level the playing field for employers while ensuring workers receive appropriate rights and protections," said U.S. Secretary of Labor Thomas E. Perez. "These federal grant awards will enhance states' ability to detect incidents of worker misclassification and protect the integrity of state unemployment insurance trust funds."

What about businesses that hire temps through a temporary staffing agency? Perfectly legal. The hiring business pays the staffing agency a flat fee. The agency then pays the temp an hourly rate, withholding taxes and contributing to Social Security and Medicare taxes. The temp is ultimately an employee of the staffing firm and is treated like one.

If you are interviewing for a job and are told the position is a contract employee, check the job description against this Small Business Administration fact sheet before you accept.

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