Posts written by Ginny Morris

Continuing our series about hiring, we look at the ins and outs of hiring independent contractors to work with your business.  Hiring contractors is a very popular way for small businesses and startups to get the work done without the paperwork and expense of hiring employees.  However, many “independent contractors” do not really fit the description and this can cause problems in the long run for the businesses that hire them.

There are several criteria that the federal government looks at to decide whether someone working for you is an independent contractor or an employee:

1) The extent to which the services rendered are an integral part of the principal’s business.

2) The permanency of the relationship.

3) The amount of the alleged contractor’s investment in facilities and equipment.

4) The nature and degree of control by the principal.

5) The alleged contractor’s opportunities for profit and loss.

6) The amount of initiative, judgment, or foresight in open market competition with others required for the success of the claimed independent contractor.

7) The degree of independent business organization and operation.

     Per http://www.dol.gov/whd/regs/compliance/whdfs13.htm

This is not a checklist and there is no requirement that the contractor fit every criteria, but this is what needs to be examined to determine if the person providing services is truly an independent contractor. 

For example, a founder who has no programming experience hires a software developer to create his product.  The services rendered are an integral part of the principal’s business but once the product is developed, the developer’s relationship with the business is over, unless the founder negotiates a separate contract for maintenance support.  The developer uses his own equipment at his own home office to develop the product and is paid a fee, negotiated with the founder, to develop the product.  The founder does not direct the developer’s day-to-day work and the developer handles his own taxes and withholding. This would most likely be found to be an independent contractor – employer relationship.

However, if we change a couple of conditions, the relationship is completely changed.  For example, the founder hires a rising senior computer science major to create the product over the summer and has her working in the founder’s office, using her computer.  The founder pays her an hourly rate for the work which she does on her own schedule.  The founder doesn’t direct her day-to-day work but expects her to show up several days a week.  She handles her own taxes and withholding.  In this situation, the developer would most likely be classified as an employee.  She does not have an independent business structure and is dependent on the employer to provide a place to work.  The employer has not contracted her for a fee but an hourly wage and expects her to show up for work.

Why would the government examine independent contractors’ relationship with their employers?  It is unlikely that the government will evaluate these relationships without an invitation from either the contractor or employer, often in the form of the contractor filing for unemployment benefits.  At that point, it is up to the employer to prove to the state that both employer and contractor understood that this was an independent contractor-employer relationship.   (The first evidence that the contractor did not understand this is that he filed for unemployment benefits.) If there is a written contract, the employer must show it contains the magic words about the contractor being responsible for his own income taxes and withholding.  The contractor will be given the benefit of the doubt because it is almost always assumed that the employer is the more sophisticated actor in the relationship.

What are the consequences of an independent contractor being found to be an employee?  There are several, depending on which part of the government makes that finding.  The Georgia Department of Labor could award unemployment benefits, requiring some additional payments from the employer for unemployment insurance.  The Georgia Department of Revenue could require the employer to pay back withholding for state income tax.  The IRS could require the withholding taxes for income tax, Social Security and Medicare for the entire time the contractor was employed and the U.S. Department of Labor could require additional payments of wages if what was paid was less than minimum wage.  Any or all of the demands for money can kill a startup or small business before it even gets going.

The best way to avoid problems:  hire companies or established freelancers as independent contractors and sign a contract that explicitly defines the work and nature of the relationship, including the magic words requiring the contractor to be responsible for their own taxes and withholding. Also, negotiate a fee for the project.  There can be contingency clauses for additional requirements, overruns, and maintenance but paying on a per project basis goes a long way toward establishing independence. 

At some point in the life of your business, you are going to think about getting someone to help you with some aspect of the business.  Among startups, this could take the form of recruiting interns, granting equity in return for work, bringing in an independent contractor, or hiring an employee.  How these paths differ and the considerations and decisions you will need to make will be the topics for the next few blog entries here.

Our first topic is interns.

To clarify, when I talk about interns, I mean unpaid interns.  Paid interns are subject to the same rules as any other employee regardless of what you call them.

Many business founders I have met look to college students who want experience as a pool of free labor by offering internships.  However, the law says that individuals who are “suffered or permitted” to work must be compensated for the services they perform for an employer.  There are a couple of very narrow exceptions to this rule, of which private sector interns are one, but they should not be considered free labor and the recruitment and use of interns must follow certain guidelines.

The rule of thumb is that an unpaid internship must benefit the intern more than the business and it must provide some sort of educational experience for the intern.  A safe way to make sure this is the case is to reach out to the intern’s major department to find out their guidelines to grant credit for outside internships.  However, this takes time, which is usually at a premium for founders.

In the alternative, there are guidelines for interns as established by the Department of Labor:

—  The internship, even though it includes actual operation of the facilities of the employer, is similar to training which would be given in an educational environment;

—  The internship experience is for the benefit of the intern;

—  The intern does not displace regular employees, but works under close supervision of existing staff;

—  The employer that provides the training derives no immediate advantage from the activities of the intern and on occasion its operations may actually be impeded;

—  The intern is not necessarily entitled to a job at the conclusion of the internship; and

—  The employer and the intern understand that the intern is not entitled to wages for the time spent in the internship.

        Fact Sheet #71: Internship Programs Under The Fair Labor Standards Act, Department of Labor, April, 2010 

These are not hard rules for internships but guidelines that will be considered in any evaluation of your intern’s program by the DOL. Your efforts to comply with these guidelines will serve as mitigation should your intern complain to the DOL or file suit.

The educational environment and benefit to the student specifically addresses the complaints of the interns from the fashion and magazine industries who sued a few years ago because their responsibilities were mostly menial tasks such as getting coffee, filing, running errands, etc. with no relationship to the business or industry for which they were interning.  Essentially, interns are not go-fers and their participation in your business should not be the same as an entry level employee of your business.  They need to have some meaningful work that teaches them about your business and should be supervised by someone from whom they can learn.  They cannot replace an employee that you would otherwise hire.  While they can perform work that benefits the business, the primary purpose of the internship is for their education and experience, not to move your business forward.

So, what happens if you do not abide by the guidelines?  Most likely nothing except you will get a reputation for being a lousy option for internship opportunities.  However, if you do have an intern who is unhappy and decides to sue for wages, there is a good chance that you will not only have to pay that intern for the time they were with you but you will also likely have a visit from  the DOL leading to penalties beyond the wages owed.  In other words, it could end up costing a lot more than any benefit you will have gained by using the intern.