Worker Classification - An Overview

Every business needs workers. So as a small business owner, you must determine how you want to classify the people who work in your company. Basically, this means you have to choose between designating your workers as employees or as independent contractors.

However, I must stress that this decision must be made with great care and deliberation. Indeed, it is imperative that you categorize your workers correctly or you could face severe federal and/or state tax consequences.  So in this post, I’ll provide an overview to help you understand the best approach to take in making these worker classification decisions.

Circumstances for Worker Classification

There are a number of circumstances that can make worker classification an issue to business owners. These situations include:

• When a new business is looking to set up efficient management and accounting practices;
• When an existing business is downsizing to reduce operating expenses and payroll taxes; and
• When a flourishing business is expanding its staff to increase productivity.

In each one of these circumstances, proper labor classification is immensely important. Both state and federal taxing authorities monitor and regularly conduct audits of businesses, with the hope of being able to impose significant retroactive penalties and interest on a business that is determined to have improperly classified employees as independent contractors.

The “Right to Control”

To discover whether or not a business has accurately classified its workers, both the state and the federal government have devised lists of factors that can be applied to the company’s structure. The purpose of each point is to determine how much control you as the owner have over your workers. The more control you exercise, the more likely it is that your business is staffed by employees, not independent contractors.

This “right to control” essentially means that you actively supervise, provide tools and convey clear expectations of how your workers should use their time fulfilling certain roles within your company. In other words, if you inspect an individual’s output, give him set hours on work days and, overall, direct his performance for you, then you are subject to paying state and federal employment taxes, Workers’ Compensation and other fees that correspond with hiring permanent employees.

State and Federal Factors

Illinois common law examines ten different factors in its “right to control” test designed to distinguish between employees and independent contractors. Although the emphasis on these factors may fluctuate, control is still the key.

The Illinois Department of Employment Security (IDES) has devised its own strict test for evaluating the status of a worker. While the IDES only considers three (3) factors, its strict pro-employee consideration of these factors almost always results in a finding that the worker is an employee, not an independent contractor. Therefore, a business owner, who has mistakenly classified his workers as independent contractors, may be forced to pay harsh penalties and interest to IDES.

On a federal level, the IRS conducts its own evaluation of worker classification based on twenty factors. Like the IDES test described above, the federal test also tends to favor a finding of a worker as an employee rather than an independent contractor. As a result, an employer could be compelled to pay an exorbitant amount of taxes, penalties and interest to the IRS, retroactive to the date of hire of the improperly classified worker.

Defending Your Business

Now that you understand what’s at stake when it comes to classifying your workers, let’s discuss how you can prevent state and federal authorities from re-classifying the categorization of your staff in a way that makes you susceptible to enormous penalties.

First of all, you need to familiarize yourself with the different factors that the state of Illinois and the federal government apply to determine worker status. Secondly, you must structure your business so that you cannot be deemed to have a “right to control” your workers. You can achieve this outcome by making your workers truly independent from your company. For example, each independent contractor must be their own separate, incorporated business with company names and business cards.

Next, you should have each corporate worker sign an Independent Contractors’ Agreement with you which includes explicit language that declares each person as independent with no obligation to you. The agreement should specify that your independent contractors can and do work for other people. So they are not tied exclusively to your business. This move minimizes the “right to control” aspect that is such a core factor to both Illinois and the federal government.

It may seem uncomfortable at first to take such extraordinary steps. But you have to keep in mind that if you don’t protect your worker classification, you could be subject to a grueling audit that will be both costly and a serious threat to the future of your business.

In my next post, I will look more closely at some of the factors that the state and federal governments use. That way, you will better understand how these factors work as a whole.

The "Cost of Collection" Clause

In this post, I’ll explain the meaning of the “Cost of Collection ” clause and I will tell you why it’s so crucial that you integrate this provision into the agreements you create with customers.

When you own a business of any sort, the business must generate revenue. Without these funds, your company cannot stay afloat. That’s just the reality of running a company.
So after your business provides services or supplies products, you naturally expect to get paid. But if you send out all of your bills and find that nobody is paying you or a client decides he’s just going to pay you whenever he wants, your business can quickly slip into a financial crisis.
Therefore, to avoid this cash flow nightmare, you have to give your customers an incentive to pay your bills to them. This incentive comes in the form of a provision within your contract called the “Cost of Collection.” By including this specific provision, you’re spelling out very clearly that there are consequences if your clients or customers ignore their responsibility to pay you.

The Last Ten Percent
Sadly, I’ve seen many of my clients lose out on the last ten percent of money owed to them by their own customers on multiple occasions. It’s a helpless feeling when you’re unable to collect the full amount of a bill after you’ve done all of the work.

What these wily customers have figured out is that this last ten percent is just small enough that a business owner won’t take them to court. It’s not worth the legal fees. Therefore, the owner is forced to abandon the recovery of that ten percent (10%) balance of his Contract, even though the money was legitimately earned.

However, this entire scenario changes if the “Cost of Collection” clause is written into a signed contract with clients or customers. The tables are turned now because you as the business owner have the enforcement rights to defeat that nonpayment strategy.

How the Cost of Collection Clause Works

If you build the “Cost of Collection” clause into your agreement with a customer and this individual fails to timely pay for services rendered, you now have a legal recourse at your disposal. You can take this customer to court to secure a judgment for the full amount of the unpaid contract balance, plus all of your attorney’s fees incurred in enforcing your contract rights.

Illinois law says you can get reimbursed for legal costs under the following circumstances:

• If the recovery is written into a contract; or
• If the recovery is written into a statute such as Consumer Fraud, which is designed to be a disincentive for deceptive business practices.

In other words, this “Cost of Collection” clause gives you the power to force a non-paying customer to promptly pay your contract balance, since it will be the customer, not you, who pays for the attorneys fees incurred in enforcing your contract rights.

By making sure that every client or vendor agreement contains a “Cost of Collection” clause, you’ll find that the people you do business with will become far more cooperative when it comes time to pay you.

Understanding Restrictive Covenants

Trust, But Restrict

               Creation of a business requires a certain amount of trust. That’s because even if you’re the driving force behind your company, you still must rely on other­­s to assist you. The reality is you just can’t perform every role yourself.

               So, trust has to be part of the equation. But problems arise, however, when you trust the wrong people. Unfortunately, some individuals won’t hesitate to steal the confidential information behind your business and profit from it at your expense.

               For this reason, it is crucial to protect your company from being raided by those within your circle of trust, by using non-disclosure agreements (NDAs) and restrictive covenants. In a recent post, I provided an overview of NDAs and restrictive covenants and I explained that they are designed to ensure that the secrets of your business do not get shared without your knowledge and consent. Now, I want to discuss these agreements in greater detail, so that you understand how they can be applied to give you the power to guarantee that the confidential information of your small business is never compromised.

NDAs

               Typically, an NDA is a one-page document that you require be signed by anyone outside your company with whom you must reveal confidential information in order to explore how this individual can enhance your business. Once the document is signed, the person is bound by this contract and is prohibited from ever revealing the sensitive information that you’ve shared, even if you ultimately determine not to enter into a formal business relationship with this individual.

               If, for whatever reason, this individual violates or even attempts to violate the NDA, you have the right to take the individual to court to secure a restraining order to keep the individual from disclosing the secrets of your business. The NDA also will allow you to have this individual pay you for all of the attorney fees that you incur to enforce the NDA. As a good business practice, always make sure that you clearly explain this aspect of the NDA, so people are well aware from the start that there are dire consequences for ignoring the terms of the NDA.  

Restrictive Covenants (Clauses)

               In contrast to an NDA, a restrictive covenant is used with individuals that are already inside your company (i.e. employees) or non-employee individuals with whom you have decided to do business (i.e. independent contractors). But the idea behind a restrictive covenant is the same as the NDA, in that restrictive covenants are designed to protect the unauthorized disclosure of your business secrets without your knowledge. Restrictive covenants /clauses typically provide three separate protections:

·        The Confidentiality Clause is similar to the NDA. Its purpose is to make sure that confidential information, such as sensitive financial information, customer lists and other trade secrets of your business (sometimes referred to as “intellectual property”), stays private. This keeps your competitors from using this sacred information to unlawfully gain a competitive advantage over your business.

 

·        The Non-Conversion Clause is a natural follow-up to the non-disclosure. It states that once new employees or independent contractors have been given access to your intellectual property, they won’t attempt to steal your workers, suppliers or vendors. Basically, your staff is barred from trying to build a separate business for themselves of for one of your competitors, based on your ingenious ideas.

 

·        The Non-Compete Clause is the final of these three essential protective documents. It tells your staff members that they cannot go out and compete with you in any form whatsoever. You want to make sure, after you have revealed the secrets of your business to trusted individuals that they won’t apply this key information, to their own company on your territory.

               All three of the restrictive covenants can be easily embedded into an existing employment agreement. That way, every member of your staff, whether full-time or part-time, will fully understand that they have clear restrictions on what they can reveal to the outside world. Equally important, these employees or independent contractors will know that if they ignore these restrictions and instead, try to profit on the back of your business, the consequences of their violating the restrictive covenants will be severe. Just like with the NDA, their violations will expose them to serious court action and personal judgments, separate from being fired.

               When you give the restrictive covenants to an independent contractor or someone whose services you’ve hired from outside your company, the restrictions should be part of your Independent Contractor Service Agreement with this individual or theses restrictions may be contained in a free-standing separate two-page document.

Duration

               Non-compete clauses remain in effect for three to five years after the employee relationship ends. Consequently, the covenant serves as a meaningful deterrent, as it blocks this person from interfering with your business and stealing your clients for a significant period of time.

               Even harsher, is the duration of the confidentiality clause. This one is typically for life. That means that the people to whom you have revealed all of your trade secrets, can never share this information with anyone without your authorization, except under extreme circumstances (i.e. court order).