Are your Independent Contractors Really Employees?

In 2013, The Internal Revenue Service went after FedEx in a big way. The IRS claimed that the individuals who apparently owned and operated a FedEx Ground route were actually employees of FedEx and not independent contractors as FedEx claimed. If the IRS had won this battle, it would have cost FedEx many millions of dollars, not only in back taxes, but also in state workers’ compensation, federal unemployment, disability taxes, Social Security, and Medicare taxes (independent contractors pay the entire 15.3 percent of Social Security and Medicare taxes, although they do get credit for half on their federal tax return).

Businesses such as FedEx select the independent contractor status because it frees them from the taxes and worker costs mentioned above by allowing the business to simply pay the contractors, leaving the independent contractor without the benefits described above. The IRS is well aware that it loses many billions of dollars due to the independent contractor status and it considers many of these independent contractors to be actual employees.  While the independent contractor status may save businesses money, it deprives workers of the benefits given to employees.  

What is the difference between an independent contractor and an employee in the eyes of the IRS? IRS Form SS-8 outlines 32 questions (and 13 questions for service providers or salespersons) that help determine the difference between an employee and an independent contractor. These 32 questions come under three main categories: Behavioral Control, Financial Control, and Relationship of the Worker and Firm. If an employer controls the independent contractor, tells him or her what to do (and perhaps even how to do it), and makes many of the decisions regarding the work, the “independent contractor” is most likely an employee. For the official form (Form SS-8, Determination of Worker Status in pdf format) that is submitted to the IRS for a decision on whether the independent contractor is considered an employee, go to www.irs.gov/pub/irs-pdf/fss8.pdf.  

No one wants to end up in a situation like the one that FedEx just came through. Even though FedEx was successful in maintaining its independent contractor status, your company may not. Companies seeking an investor or buyer should confirm their legal and HR compliance, as the Due Diligence process can uncover people who are misclassified as independent contractors. This could provide a substantial hurdle that could make a deal fall apart.