Contract Employment -- Risky Business
By S. Joseph Baker, CPC
On the surface, contract employment is an easy and convenient arrangement
between companies and workers. Scratch the surface, however, and you may find
it's risky business.
Are these statements true or false?
- Contract employment is a viable, risk free option for employers who don't
want to hassle with the problems of "real" employees.
- Company employees who hire or work with contractors have nothing at
stake.
- Contract employment is a real boon for workers: no commitment, no risk
and lots of flexibility.
The answers: false, false and false.
Whether you're an employer, employee or a contractor - beware. The practice
of contract employment should come with a warning label. The legal and financial
implications not only are complex but constantly shifting.
RISKS FOR ALL
Employers. How do you define "employee" and "contractor"? Until recently, by
playing "20 Questions" with the Internal Revenue Service: Do you set the
workers' hours? Do you provide tools?
Recently, the IRS came up with one key question: How much control do you
exercise over the worker? But, whether it's one question or 20, the issues
remain murky.
If the IRS decides after-the-fact that the contractors really are employees
and income tax is owed on the contractors' earnings, guess who gets stuck with
both sides of the tax bill? The employer, of course, who incurs additional
expenses associated with penalties and interests, retroactive employee benefits
and unemployment insurance for the former contractors.
Employees. Your boss tells you to hire contractors to circumvent approval
processes, budgets, unemployment insurance, workers' compensation rates. Or
perhaps you just work for a company that regularly uses them. In either case,
you feel that contract labor has nothing to do with you, a legitimate employee.
Wrong. If you make contributions to a qualified retirement plan and take the
allowable tax deductions, you're at risk financially. (The same is true for your
employer, in the case of employer contributions to a qualified plan.)
Of course, contractors are not eligible for such a retirement plan - unless
the IRS decides, after the fact, that they were actually employees. That means
they were and are eligible for the plan but haven't been included. This can lead
to a technical disqualification of the plan and a loss of its tax break, plus
related penalties and interest.
Contractors. As a contractor, you consider yourself a self-employed
individual with all the associated freedoms. But you have no
company-sponso#666600 retirement plan, so you establish one and take the allowed
tax deduction on payments.
If the IRS later decides that your status on any given job was employee,
rather than contractor, guess what you've got to lose - the tax deduction on
your retirement plan, plus the expenses of associated penalties, interest,
etc.
ALTERNATIVES
Companies can get all the benefits of direct contract employment without the
associated risks by having a third party take on the role of "employer" and
assuming the risks and responsibilities involved - risks associated with hiring,
payrolling and terminating workers.
Alternatives to direct contracting include:
Temporary workers. The
practice of hiring temporary workers - traditionally for short-term secretarial
and clerical work - now has expanded to include most corporate professionals.
However, temporary personnel firms, for the most part, still fill short-term
and
readily replaceable positions. Most are not in the business of providing
uniquely skilled, hard-to-find workers.
Employee leasing. Employee leasing is actually a contractual arrangement
between an employer (the leasing company) and a company which does not desire to
employ its workers directly. Companies with employees may terminate them to
establish a leasing arrangement through a third party (with the employees
continuing to work as before). The leasing company handles the payrolling and
assumes the risks. Most leasing firms offer employees a full range of benefits,
which may add to the cost of leasing.
Third-party contract firms. Some third-party employment firms just provide
payrolling services while they assume the liabilities of the employer. This is a
lowcost alternative to employee leasing because employee benefits usually aren't
part of the package. This alternative proves most cost effective when the
company has already identified the prospective employee and recruiting services
are not needed.
Contract recruiting firms. Contract recruiting firms can locate, hire and
payroll professional workers on a project basis, either temporary or
long-term.
Of course, hiring contractors directly with its inherent risks - will remain
an option in today's workplace.
A word of caution, however: if you're paying employees as contractors and
think you won't get caught, think again. The IRS is in a heightened phase of
auditing corporations that send 1099s to individuals. Workers with single-source
income are flags.
Also, if the "contractor" gets hurt on the job and sues for workers' comp
benefits, the employer may find himself in a legal battle with no
indemnification from his insurance company.
Also, "contractors" have been known to apply for unemployment benefits and
state agencies that see no wages reported for that individual will review the
question of contractor vs. employee. In most cases, they'll side with the worker
and alert the IRS.
S. Joseph Baker CPC is president of Search Consultants International Inc., an
executive recruiting and contract engineering firm. Reprinted with permission
from the Houston Business Journal
