Business owners have a lot at stake when it comes to determining whether persons connected with their ventures are employees or independent contractors. The largest issue with making this determination involves taxes and insurance.
A business has specific responsibilities for employees, having the legal obligations to withhold and pay certain taxes (Medicare, Social Security) and pay other taxes (unemployment). If a business makes a mistake with classifying employees, it faces the financial burden of paying additional taxes and could well be punished with substantial fines. However, there are issues that are just as critical regarding determining a service provider’s status and insurance.
Many forms of both property and liability business insurance define the persons who qualify for protection under a given insurance policy. Property coverage is written for the direct benefit of the first party, the party who owns (or in other cases, has control or custody of) either real or business personal property. Liability coverage is written on behalf of persons defined as insureds, protecting them against harm they may cause to others or for damage they cause to property that belongs to others.
Employees are commonly granted coverage status in a variety of instances. However, coverage typically is not available to independent contractors who are considered unrelated third parties. FYI, under insurance contracts, the second party is the insurance company. Therefore, in many instances, if persons suffer losses under either property or liability policies, it is critical to be certain whether an individual is an employee or is independent.
Because of the position held by policyholder/insureds and insurance companies, the classification of workers is often in conflict as insureds desire liberal coverage and insurers wish to restrict protection to qualified persons. However, both parties are best served when worker classifications are clear. Premiums charged to policyholders are based on correctly recognizing the parties eligible for coverage. Proper classification keeps coverage affordable and makes the insurance process more efficient. Coverage involving employees should be connected to an applicable business that employs them. Coverage involving independent contractors should be connected to the contractors. In other words, they should secure their own, separate coverage.
In the U.S., common law helps determine worker status. Some confusion is created by improper focus on a given work relationship. Instead of a narrow focus, proper worker classification is a result of looking at the total work situation in which an individual performs a job. Essentially, classification is a matter of control. Specifically, consider the following areas:
Behavioral – Who has primary control over how work is done, the business or the worker?
Financial – Who controls how a worker is paid, how are expenses handled, who is responsible for supplies and tools that are needed for work?
Relationship – What defines the work relationship, manner of pay, what benefits are in place, does worker have paid vacation and what is the nature of the relationship?
It’s important that all the above factors be considered when evaluating a worker classification.
Evaluation should be performed on a simple scale. The greater the control by a given party determines how to make a classification. If a business exerts the greater overall control, the worker is an employee. If the individual worker exerts the greater overall control, the worker is an independent contractor.
Practically speaking, areas of control involve the level of freedom a worker has in getting tasks done, but another element is the nature of the work. Some businesses want to minimize both their tax liability and legal liability (and related payroll costs) by use of independent contractors. However, the situation can’t be a façade. If workers have an ongoing relationship with the applicable business because the work is normal for that business, likely the work involves employees. When the work is unusual for the given business and lasts for a short period, especially when it involves specialize labor or skills not existing in that business, the work likely involves independent contractors.
If a business or a worker is unclear over a classification, help is available from the IRS. Specifically, a work situation description can be submitted to the IRS to get its interpretation. Having that department’s help (and documentation) for a situation could be quite helpful in dealing with both tax and insurance matters.