Independent contractors are a popular choice for business owners to fill their work force needs, especially during the startup phase of their business. True independent contractors are not treated as employees, which essentially means that payroll taxes and certain state and federal employment laws do not apply to the contractors and the business is exempt from those requirements. However, it is important to ensure that a worker qualifies as an independent contractor because the repercussions for incorrectly classifying workers can be severe.
A recent article in NY Magazine explored this issue with respect to a venture-backed startups in Silicon Valley (namely Homejoy). The gist of the article was that, the author, after hiring Homejoy to clean his house, was surprised to learn that the cleaner that came to his house was homeless and was not an employee of Homejoy. Rather, the cleaner was classified as an independent contractor.
Generally, the analysis of whether an individual is, in fact, an employee or independent contractor is determined by the Internal Revenue Service’s 20-factor test. Typically, no single factor is necessarily dispositive of how the relationship will be categorized. Thus, it will come down to a balancing of all of these factors.
With 20 factors to balance, it is extremely important that a business seek legal counsel to assist it with properly structuring, documenting, and implementing the relationship within their business. Misclassifying workers as independent contractors can have significant consequences, including, but not necessarily limited to, back pay of taxes and withholdings (employment taxes, FICA, FUTA, benefits contributions, penalties, interest, etc.), becoming subject to employment and wage laws (e.g., minimum wage laws, overtime laws, workers compensation, and other employment laws). This can obviously be a devastating consequence for many businesses.
In addition, I suspect that, given the “1099 model” of many startups these classifications may become issues during diligence periods when the startup seeks financing or is being vetted as an acquisition target.
So, the bottom line is that, if you are going to implement workers as independent contractors, you need to work closely with a competent corporate attorney to assist you with the structuring, documentation, and implementation of the relationship.