What's in a Name?
Misclassifying Employees as Independent Contractors Can Be Costly

Are tax advantages tempting your staffing firm to classify workers as independent contractors instead of employees? The Internal Revenue Service has long recognized this temptation, and giving in to it can have serious consequences for your staffing firm—and your clients.

If a worker is an employee, the employer must pay its share of Social Security (FICA) and federal and state unemployment taxes, as well as withhold the employee's share of federal income and FICA taxes. The employer also will incur costs related to pensions, health insurance, vacation pay, sick pay, and workers' compensation insurance. In addition, employers face federal and state regulations regarding working conditions and overtime.

Given such employer obligations, over the years ASA has received a number of calls from members complaining about other staffing firms that improperly classify their workers as independent contractors. These firms can gain a competitive advantage by charging less for their services because they do not pay for workers' compensation, unemployment insurance, or Social Security, and they do not withhold taxes from the people they send on assignment. The rules governing worker classification are complex and, at times, have led to confusion about how temporary workers should be classified. In the great majority of cases, the individuals assigned by these firms really are employees because of the nature of the work they perform and their relationship with the firm assigning them or with the client.

There are various tests—under various laws—to determine whether a worker is an independent contractor or an employee. The IRS examines 20 factors for federal employment tax purposes. These factors generally encompass criteria used to make a determination under many other laws. The more factors that are present in a staffing firm's relationship with its worker, the more likely a worker will be an employee and not an independent contractor. These factors include whether

• The staffing firm or client has the right to instruct or direct how work is performed
• The worker undergoes training
• The work is integrated into the client's business
• The client hires and supervises assistants to help the worker
• The services must be rendered personally
• There is a continuing relationship with the worker
• The worker works set hours
• The worker must devote his or her full time to the assignment or task
• The worker works on the client's or staffing firm's premises
• The worker must perform tasks in a particular order
• The worker must submit written or oral reports
• The worker is paid hourly, weekly, or monthly
• The staffing firm or client pays the worker's business and travel expenses
• The staffing firm or client provides tools and materials for work
• The worker does not have a substantial investment in facilities used to work
• The worker can realize a profit or suffer a loss in connection with the services
• The worker works only for the staffing firm or client
• The worker does not make his or her services available to the general public
• The staffing firm or client can discharge the worker
• The worker can terminate his or her relationship with the staffing firm or client without incurring liability

Most workers assigned through a staffing arrangement perform their work under the supervision and control of either the staffing firm or the client, and the work performed generally is of a nature that does not require the worker to exercise a substantial degree of independent judgment. While exceptions do exist—especially in the information technology field—most assigned workers can properly be classified only as employees under applicable law.

If an assigned worker is an employee and the firm that assigns the worker nevertheless classifies him or her as an independent contractor, the firm can face significant fines and penalties for, among other things, failure to withhold taxes, pay Social Security, provide insurance coverage, and pay overtime.

In addition, the staffing firm's client may be held liable for those costs as a joint employer if the firm assigning the worker is unwilling or unable to pay. Therefore, improper worker classification poses significant risks to both the staffing firm and its clients.

Consider sending your clients a cautionary letter to alert them to their potential liability if they use the services of independent contractors who are really employees, and to highlight some of the criteria used to determine whether workers are really employees. Sample language for such a letter is provided in the sidebar.

By using this letter, staffing firms may cause clients to rethink their use of firms that may be improperly classifying workers. Such staffing firms, in turn, may scrutinize their practices to ensure compliance with the law, thus leveling the competitive playing field.

For additional information on proper classification of workers, refer to the 11th edition of Employment Law for Staffing Professionals.

Stephen C. Dwyer, Esq., former deputy general counsel for the American Staffing Association, is senior vice president and general counsel for ASA member Oxford Legal Associates.