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dent contractors.
There are several advantages and disadvantages to hiring employees. It can
be easier to foster a sense of commitment, culture, loyalty, and teamwork in
employees than in independent contractors. Hiring full-time employees also
gives the employer a greater amount of control over the way employees do
their work and allocate their time. On the other hand, hiring employees obli-
gates the firm to pay payroll and other taxes and makes your business subject
to numerous federal and state laws that must be navigated. Several of these
laws are discussed later in this Chapter.
Hiring independent contractors presents a different set of issues. Inde-
pendent contractors are typically hired to complete a particular project in a
particular amount of time or to provide a specific skill-set. As such, contrac-
tors are generally entitled to determine how and even when and where to
complete their assigned project. However, a business owner does not have to
pay taxes or withhold income tax on money paid to an independent contrac-
tor. Depending on the needs of your business, hiring an independent con-
tractor may or may not be a possibility. Typically independent contractors
may be hired for specific engagements, but will generally not constitute the
backbone or bulk of the firm™s professional staff.
Even if a firm agrees to hire a person as an independent contractor, the
firm™s characterization of the relationship is not binding on others, such as the
IRS. Depending on several factors, such as the amount of control over where,
when, or how a person does his or her job and the permanency of the relation-
ship, a person whom you initially hire as an independent contractor could later
be deemed to be an employee, and your business, or you, may be liable to pay
back payroll taxes or other benefits. Also, you may be liable for the conduct of
the worker if he or she is later found to be your agent or employee; this is par-
ticularly troubling because your insurance company may exclude the lawsuit
from coverage because the act was committed by someone you told the insur-
ance company was an independent contractor. If you are considering hiring in-
dependent contractors, having a lawyer help you determine whether, given the
type of help you need, the people you hire can be classified as independent
498 The Back Office: Efficient Firm Operations

contractors as opposed to employees can be well worth the money you spend
in legal fees. You should also check with your insurance broker to make sure
that any persons working for your business are covered by your general liabil-
ity or automobile insurance, particularly if the workers are on the road for
your business. Alternatively, you should demand proof of insurance from any-
one working for you as an independent contractor. IRS publication 1779 pro-
vides an overview of IRS policies regarding this relationship. Exhibit 19.1
shows a summary of the characteristics of employment versus contractor rela-
tionships established by the IRS, often known as the “20-factor” test.1 The IRS
will make a determination for firms regarding the employment status of indi-
viduals. Firms can submit an IRS form SS-8 for this process. As noted at the
end of this chapter, this is provided for informational purposes only and firms
should consult an attorney regarding their specific situation.
Exhibit 19.2, summarizes a few of the related forms and publications
available from the IRS regarding employment relationships.2

LAWS GOVERNING THE EMPLOYER-EMPLOYEE RELATIONSHIP. Once
you make the decision to hire employees, a wide range of federal and state
laws apply.

Minimum Wage and Maximum Hours”the Fair Labor Standards Act (FLSA)
and State Law Requirements. One of the most basic laws that applies to em-
ployees is the FLSA, the federal law that requires payment of a minimum
wage and one and one-half an employee™s pay rate for overtime worked. The
FLSA distinguishes between what the law calls “exempt” and “nonexempt”
employees. Exempt employees are excluded from the FLSA™s coverage. Ex-
empt employees include certain executive, administrative, and professional
employees. Each of these categories has its own specific definitions and re-
quirements, including minimum salary requirements, so it is useful to consult
with a lawyer to ensure that someone who you believe may be exempt from
the FLSA™s requirements actually is exempt. Job titles alone are not determi-
native. In recent years, an increasing number of lawsuits have alleged that
employees who should be classified as nonexempt have been misclassified as
exempt and, thus, not given overtime pay. In such cases, the employer can be
liable for a substantial amount of unpaid overtime and, in some cases, penal-
ties for willful misconduct.
Employees who are nonexempt must be paid the federal minimum wage,
which is currently $5.15 per hour. There are a number of U.S. states which
have established higher minimum wages. Exhibit 19.3 has a summary of cur-
rent minimum wages in states that exceed the Federal minimum.3 As with
any labor laws, these will change from time to time at the federal and state
level and the firm should ensure that they are in compliance with the most
recent applicable laws.
There are other exceptions to this rule as well. For example, food servers
who earn tips can be paid a lower base wage rate as long as the tips they
499
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EMPLOYEE OR INDEPENDENT CONTRACTOR?

Whether someone who works for you is an employee or an independent contractor is
an important question.The answer determines your liability to pay and withhold
Federal income tax, social security and Medicare taxes, and Federal unemployment tax.
In general, someone who performs services for you is your employee if you can
control what will be done and how it will be done.
The courts have considered many facts in deciding whether a worker is an
independent contractor or an employee.These facts fall into three main categories:
1. Behavioral control: Facts that show whether the business has a right to direct
and control.These include:
a. Instructions: An employee is generally told:
i. when, where, and how to work
ii. what tools or equipment to use
iii. what workers to hire or to assist with the work
iv. where to purchase supplies and services
v. what work must be performed by a specified individual
vi. what order or sequence to follow
b. Training“an employee may be trained to perform services in a particular
manner.
2. Financial control: Facts that show whether the business has a right to control
the business aspects of the worker™s job include:
a. The extent to which the worker has unreimbursed expenses
b. The extent of the worker™s investment
c. The extent to which the worker makes services available to the relevant
market
d. How the business pays the worker
e. The extent to which the worker can realize a profit or loss
3. Type of relationship: Facts that show the type of relationship include:
a. Written contracts describing the relationship the parties intended to create
b. Whether the worker is provided with employee-type benefits
c. The permanency of the relationship
d. How integral the services are to the principal activity

For a worker who is considered your employee, you are responsible for:
• Withholding Federal income tax,
• Withholding and paying the employer social security and Medicare tax,
• Paying Federal unemployment tax (FUTA)
• Issuing Form W-2, Wage and Tax Statement, annually,
• Reporting wages on Form 941, Employer™s Quarterly Federal Tax Return.

Exhibit 19.1 IRS Guidelines for Establishing Employee and
Contactor Relationships
500 The Back Office: Efficient Firm Operations

Tax Topic 762 Basic Information: To determine whether a worker is an independent
contractor or an employee, you must examine the relationship between the worker
and the business. All evidence of control and independence in this relationship
should be considered.The facts that provide this evidence fall into three categories
Behavioral Control, Financial Control, and the Type of Relationship itself.

Publication 1976, Section 530 Employment Tax Relief Requirements (PDF): Section 530
provides businesses with relief from Federal employment tax obligations if certain
requirements are met.

IRS Internal Training: Employee/Independent Contractor (PDF): This manual provides
you with the tools to make correct determinations of worker classifications. It
discusses facts that may indicate the existence of an independent contractor or an
employer-employee relationship.This training manual is a guide and is not legally
binding. If you would like the IRS to make the determination of worker status,
please file IRS Form SS-8.

Form SS-8 (PDF): Determination of Worker Status for Purposes of Federal
Employment Taxes and Income Tax Withholding

Publication 15-A: The Employer™s Supplemental Tax Guide has detailed guidance
including information for specific industries.

Publication 15-B: The Employer™s Tax Guide to Fringe Benefits supplements Circular
E (Pub. 15), Employer™s Tax Guide, and Publication 15-A, Employer™s Supplemental
Tax Guide. It contains specialized and detailed information on the employment tax
treatment of fringe benefits.

Exhibit 19.2


receive reach a high enough level. Generally, if a nonexempt employee works
more than 40 hours in a workweek, that employee must be paid overtime pay
at a rate of not less than one and one-half times the regular rate of pay.

Discrimination and Related Legal Issues. Federal and state laws broadly
prohibit discrimination on a variety of grounds in all aspects of the employ-
ment relationship, including the hiring, training, paying, promoting, disciplin-
ing, and terminating of employees. A lawyer can help you navigate these
important laws.
Under Title VII of the Civil Rights Act of 1964, it is illegal to discriminate
against a person in the terms and conditions of his or her employment because
of race, color, religion, sex, or national origin. The Age Discrimination in Em-
ployment Act (ADEA) makes it illegal to discriminate against a person be-
cause of age if he or she is over 40. The Equal Pay Act generally mandates
that men and women be paid the same for the same work. The Americans
with Disabilities Act (ADA) prohibits discrimination against a qualified
501
Legal Counsel

MINIMUM
STATE WAGE ($)

Oregon 7.05

California 6.75

Alaska 7.15

Illinois 5.50

Rhode Island 6.75

Massachusetts 6.75

Maine 6.25

Vermont 6.75

Washington 7.16

Hawaii 6.25

Delaware 6.15

Connecticut 7.10
Exhibit 19.3 Mimimum Wage
Standards by U.S. State



person with a disability and imposes on covered employers the duty to pro-
vide a “reasonable accommodation” to an employee™s or prospective em-
ployee™s disability. Under the Family and Medical Leave Act (FMLA), larger
companies”that is, those with more than 50 employees”must honor the
need of employees to take leave from work to care for a newborn or to care
for a family member ™s, or the employee™s own, serious health condition.
Still other perhaps less well-known but important federal laws exist. These
laws include provisions of the Civil Rights Act of 1866, which prohibits racial
discrimination in the making and enforcement of contracts (and thus applies
to independent contractors); the Employee Retirement Income Security Act
(ERISA), which regulates employee benefit plans and pension plans; the Oc-
cupational Health and Safety Act (OSHA), which imposes various health and
safety standards on employers; and the Comprehensive Omnibus Budget Rec-
onciliation Act of 1986 (COBRA), which requires employees to be notified of
their right to continue health insurance coverage for up to 18 months after
termination. Finally, if you intend to do business with the federal government
or with someone who does business with the federal government, you should
consider whether you will be required to adopt an affirmative action plan and
502 The Back Office: Efficient Firm Operations

otherwise comply with the federal government™s requirements concerning
obligations to minorities, women, persons with disabilities, and veterans.
Although some of these federal laws do not apply to the smallest employ-
ers (e.g., Title VII generally applies only to employers with 15 or more em-
ployees), state laws that mirror or are broader than these federal laws might
still apply. These state laws can be equally as important as their federal
counterparts. For example, many states (and some local authorities, such as
city or county governments) prohibit discrimination in employment on the
basis of a person™s sexual orientation, and practically all states prohibit retal-
iating against employees for filing a workers™ compensation claim. States also
have a wide variety of court-made rules that prohibit discharging employees
for violating what courts declare to be the state™s fundamental public policy.
Although many of these “public policy” cases involve situations in which an
employee claims that he or she was fired for refusing to break a law, the law
in some states is broader.
The list of laws that provide protection to employees goes on. Retaining a
lawyer to review your business™s employment practices can help you avoid
the legal pitfalls that can trap the unwary.

POLICIES, PAPERWORK, EMPLOYEE HANDBOOKS, AND OTHER EM-
PLOYMENT ADVICE. Another reason to consult with a lawyer is to create
and improve your business™s written policies and record keeping practices.
Having detailed company rules and policies on, among other things, work
hours, absenteeism, telephone and Internet usage, confidentiality, smoking,
drug use, dress, equal employment opportunity, and harassment is essential.
For example, one way to defend against many sexual harassment claims is to
show that your business has an enforced, written policy that forbids harassing
conduct and provides avenues through which employees can complain about
actions they may feel to be harassing. Employees who claim to be victims of
harassment but who fail to avail themselves of such a policy have a more diffi-
cult time succeeding in court. A lawyer who has an opportunity to learn the
needs of your business can help you draft a full set of policies specifically tai-
lored to your needs and can help you create or review an entire employee
handbook, if appropriate. A sample of the topics which an employee handbook
may address is included on the CD which accompanies this book.
Similarly, although lists of job qualifications and job duties are not specif-
ically required by any law, they are useful and should be reviewed by a
lawyer prior to implementation. Having a list of the “essential functions” for
each position in your business can clarify your duty to reasonably accommo-
date an employee™s disability. Additionally, creating a list of job qualifica-
tions can help you analyze what skill sets you need for your business™s
employees. However, some job qualification requirements can lead to claims

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