Worker Classification: Part Two

In my last post, I explained the critical importance of properly classifying your workers as either employees or independent contractors. Indeed, I warned you that if you do not classify your workers in accordance with state and federal guidelines, your staff incorrectly, your business could be subject to hefty penalties and retroactive interest.
Since it is so important to understand how the State of Illinois and the federal government evaluate the status of a worker, I’d like to discuss this subject in greater detail. That way, you’ll become more familiar with the evaluation factors, so you can better protect your business.

Illinois’ Factors

As I’ve previously mentioned, the Illinois courts rely on a ten factor “right to control” test. This tool enables the state to conclude whether or not your workers are employees or independent contractors. The difference between the two types of workers matters from a governmental perspective for purposes of employment benefits and taxation.
These ten factors cover a wide range of circumstances. Most importantly, Illinois wants to know how closely you manage your worker. For instance, does this individual receive training, materials and direction from you? If so, it is likely that the state will conclude that you “control” the worker and therefore, this worker is properly classified as a “controlled” employee rather than an “uncontrolled” independent contractor.

Other aspects include:

·        Worker engagement – Illinois will look at whether or not the worker performs duties for other employers. If he is exclusively employed by your business and is not available for hire, then the state will see him as an employee.

·        Worker skill – The state evaluates the amount of skill needed to do the work in a particular company. In general, if more expertise is necessary, the state tends to classify the worker as an independent contractor.

·        Employment length – The period of time a worker has offered you services can make all the difference to the Illinois courts. If this individual has worked in your company for a short time, she’ll usually be viewed as an independent contractor. Conversely, a worker who has a longer history with your business will probably be recognized as an employee.

·        Payment method - If you pay your workers on a project-by-project basis, chances are that the state will see these individuals as independent contractors. On the other hand, salaried or hourly workers are more likely to be categorized as employees by Illinois.

·        Integral or ancillary – An integral worker is considered part of the company’s regular business. The fact that he performs a key function in the business, it’s probable the courts will look at him as an employee. At the other end of the spectrum is the ancillary worker, who is an occasional contributor to the company and not involved in its operations on a consistent basis. The ancillary worker will likely be viewed as an independent contractor.

In general, the underlying theme to remember is how much control the business exerts over its staff members.

Similar to the state’s court system, the Illinois Unemployment Insurance Act examines the amount of power you have over your workers in order to determine the correct categorization. But instead of ten factors, there are only three. Furthermore, all three of these circumstances must be met for a worker to be recognized as an independent contractor. Otherwise, the worker is deemed to be an employee.

Below are the factors this statute systematically applies:

·        The business does not control the worker’s performance.

·        The service cannot take place during the normal course of business or at the physical location of the company.

·        The worker has to offer an occupation or profession that’s separate from your business.

Again, control is the key. This means that the less supervision you have over a worker, the better the argument for classifying this individual as an independent contractor.

The Internal Revenue Service’s Factors

Like the state of Illinois, the Internal Revenue Service (IRS) also evaluates employment status based on the right to control. Therefore, if you direct, train and integrate workers’ services into your business operation, for example, it’s reasonable to expect the IRS to define your staff as employees rather than independent contractors. This means that you’ll be required to pay certain taxes and possible penalties, if you have misclassified your workers.

While the amount of regulation over your workers is a critical element of the federal government’s final judgment, other components are also involved to generate this decision. In total, the IRS relies on twenty different factors. These essential circumstances include:

·        Reports – If a business requires written or oral reports as part of the job, then the IRS could assume the worker is an employee. This consistent expectation suggests the worker is regularly supervised, which supports the government’s theory of permanent employment.

·        Payment of expenses – If a company covers workers’ travel or business expenses, the government may conclude they are employees. That’s because the payment is interpreted as control over the workers.

·        Realization of profit or loss – If workers can experience a profit or loss as a result of providing services to a business, they will be probably be viewed as independent contractors.

·        Working for numerous companies – If a worker provides products or services to several unrelated businesses, it’s likely the IRS will see him as an independent contractor.

·        Right to discharge – If a business has the right to discharge its workers, then the IRS might regard these individuals as employees. An independent contractor is protected from being fired unless he does not live up to contract specifications.

·        Right to terminate – If a worker can terminate her employment without any liability, then the federal government will generally look at this individual as an employee.

Need More Help?

Worker classification encompasses many detailed factors. So it’s understandable to feel overwhelmed by the numerous elements. But as a small business owner, you need to be aware that if you group your workers incorrectly, you could face harsh tax consequences.

However, my team and I at DregerLaw are well-versed in all of the factors the state and federal governments use to determine worker status. Let us make sure you’ve designated your staff correctly.

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.