Business owners often pay workers as independent contractors rather than employees for financial reasons.  However, misclassification of employees as independent contractors is a serious problem. When workers don’t actually meet the legal test for independent contractor status, the employer is exposed to significant legal liability. A misclassification mistake can result in civil penalties; liability for unpaid wages, including potential overtime pay; liability for meal and rest breaks; liability for employment taxes; and more.  Here, we debunk five common myths that could harm your business if believed and acted upon.

Why do Businesses Want to Pay Workers as Independent Contractors?

Being classified as either an employee or an independent contractor can determine whether workers have access to reliable pay, overtime, benefits, and protection from discrimination.  Employers enjoy a host of benefits by treating workers as independent contractors.

Independent Contractors:

• Pay both employer and employee payroll taxes

• Are not covered by minimum wage or overtime laws

• Are not eligible for unemployment benefits

• Are not eligible for healthcare, retirement, sick time, or family leave benefits

• Cannot form a union with other workers

• Are not generally protected by employment laws such as the Fair Labor Standards Act, the Family and Medical Leave Act, which guarantees unpaid time off and continued health insurance coverage around the birth of a child and other circumstances, and the Employment Non-Discrimination Act, which protects employees from discrimination and harassment.

In short, employers avoid exposure to nearly all the rights to which employees are entitled under federal and Pennsylvania when they treat their workers as independent contractors.

Myth 1 He Wanted to Be Classified That Way

Many employers mistakenly think that if the worker asked to be treated as an independent contractor, they are safe. The intent of the worker is just one factor that enforcement agencies and the courts will consider and certainly is not dispositive. You can’t base your classification decision on accommodating the workers’ preference or your own preference. You must make sure that your hire is properly classified using the legal tests. Federal and Pennsylvania law start with the presumption that a worker is an employee.

Courts and labor departments generally look to the degree of control the employer exercises over the worker; the more control the employer has over the details of how and where the work is done, the more likely the worker is an employee and not an independent contractor. True independent contractors need to be able to exercise meaningful discretion to accomplish their work. Are you exercising control over how the worker accomplishes the job? Is the work an integral part of your business? Is the worker economically dependent on you or truly in business for himself? These are just some of the factors that will be examined. Look at the reality of the situation, not the label applied.

Myth 2 We Have a Written Agreement with Her

A written agreement is not enough by itself to make a worker an independent contractor and is not absolute protection from liability for misclassification. If the actual working arrangement doesn’t meet the legal tests for independent contractor status, what you call the worker in a written document does not matter. Courts and regulators often disregard written independent contractor agreements. Instead, courts and regulators look at what is actually going on in the day-to-day working relationship, regardless of what the document says.

Does this mean you shouldn’t have a written agreement? Absolutely not. If you have a worker who meets the independent contractor tests, then you will want to put an agreement in place. Just remember that an agreement alone will not turn an improperly classified worker into a properly classified one.

An independent contractor agreement can be a helpful factor if properly drafted and preferably reviewed by an experienced business or employment attorney. On the other hand, an improperly drafted agreement may end up being used against you in a misclassification audit or lawsuit. The agreement needs to be customized to reflect the actual terms of the particular working relationship and should not be a boilerplate agreement used for all contractors. Put procedures in place to revisit a contractor’s agreement if the job duties or expectations change over time.

Myth 3 Small Businesses are Exempt from Classification Rules

“I only hire a handful of workers. Classification rules don’t apply to me.”  This myth probably stems from rules around providing health insurance and other benefits. Businesses with fewer than 50 full time employees are not legally bound to provide health coverage for their workers. The same is true for parental leave, where small businesses are not bound by the Family Medical Leave Act, which allows up to 12 weeks of leave after having a baby. As employment laws are known to be complex in America, it’s easy to see why many enterprises think that they do not have to worry about classification if they have fewer than 50 workers in place. 

The reality is that classification rules apply to all businesses.  You can have one person working for your organization, and still misclassify them, leading to fines and penalties from the IRS. Classification is not related to how many people you have working for you. Even small businesses with under 50 workers need to be sure they are classifying workers correctly. If you have inadvertently been classifying employees as contractors, you can limit fines and penalties by applying for the Voluntary Classification Settlement Program, a great way to grab a clean slate. 

Myth 4

It’s OK to Have My Independent Contractor Use a Timesheet

You should not pay independent contractors the same way you pay your employees — for instance, don’t pay on an hourly or weekly basis or with a guaranteed payment, such as a salary, and don’t put them on your payroll. Enforcement agencies often view this as proof of employee status. You should require your independent contractor to submit an invoice to you for work done, ideally on a per-project basis. The contractor also should have an employer identification number (EIN) and not just use a personal Social Security number. Independent contractors should receive the Form 1099 for amounts paid to them and be responsible for their own employment and income taxes.

You should not be reimbursing independent contractors for any expenses they incur. Submitting invoices, having an EIN and receiving a Form 1099 instead of a Form W-2 will not guarantee that the person is truly an independent contractor, but these items can help. Keep in mind, however, that enforcement agencies will look beyond these formalities to examine the underlying substance of the worker relationship and whether it really is an employer-employee relationship.

Myth 5

I’m a Small Business and Unlikely to be Audited

If you think you won’t get caught because you’ve never heard from the Department of Labor for anything, don’t work in high-risk industries or hire a high volume of workers, think again. Several things could trigger an audit revealing your worker classification practices:

• Companies can get audited for worker classification issues if an independent contractor you no longer work with struggles to land their next gig and puts in a claim for unemployment compensation and identifies you as the former employer of record.

• You can be audited for worker classification if the independent contractor suffers an on-the-job injury and submits a worker’s compensation claim that identifies you as their former “boss” and employer of record.

• If you have a dispute with an independent contractor who submits a complaint to the Department of Labor’s Wage and Hour Division, you could be audited.

• If the worker files their taxes and you are the only employer listed on Form 1099, especially if it appears to be a full-time income, it can trigger an audit.

Just because you issue a particular tax form to a worker doesn’t mean that designation was legally accurate. It doesn’t matter if you work in high-risk industries or don’t hire many people.

Understanding the truths behind independent contractor relationships is crucial for minimizing legal risks. You could be personally liable for unpaid wages and payroll taxes due to misclassification errors.  By debunking these myths, you can create a more sustainable and compliant business model. Bear in mind that consulting one of Fiffik Law Group’s experienced small business attorneys for tailored guidance is always a wise step to ensure you're navigating these waters correctly. Don’t let misconceptions hurt your business—stay informed and prepared!