May an employer convert some or all of its employees to independent contractors and thereby avoid paying employment-related taxes and benefits?
While all tax related issues are best answered by an accountant, there are legal issues to consider. An independent contractor is a worker who is self-employed and who performs work for an employer on a project or contractual basis. While an employer must pay for state or federally mandated benefits for its employees – such as Social Security, worker’s compensation and unemployment compensation – independent contractors are not entitled to such benefits. In addition, an employer is required to withhold payroll taxes from an employee’s pay, while an independent contractor must pay his or her own taxes. Thus, employers may save considerably by hiring independent contractors.
However, a job title or even the employer’s own designation does not legally categorize a person as an independent contractor or an employee. Likewise, the existence of a contract stating the employment relationship is that of an independent contractor alone is not sufficient to determine the nature of the relationship. Rather, whether a worker is an employee or an independent contractor is determined by the duties actually performed by the worker and the degree of supervision and control that the employer exercises over the worker.
An employer whose contractors are retroactively determined to be employees may be required to pay back employment taxes and penalties. In addition, if the employer sponsors certain employee benefit plans for its employees, such as health insurance or a pension program, the employer may be required to provide the misclassified employees with those benefits retroactively, depending on the terms of the individual benefit plans. Therefore, before converting employees to independent contractors, an employer should consult an attorney and accountant to make sure that the workers actually meet the qualifications for an independent contractor.