Employment: Contractor vs. employee

If you don’t know the difference, you could wind up in jail.

By James Myers

The auction industry can be particularly vulnerable to a problem that can lead not only to bankruptcy, but also jail time.

It occurs when an independent contractor is found by state and federal agencies to be misclassified and actually fits under the description of an employee. The issue is only magnified by the fact that the guidelines what defines an independent contractor can differ per investigator.

NAA member Rich Schur, CAI, BAS, MPPA, said it’s a topic he discussing during a three-hour CAI session.
“Of the many regulatory things Auctioneers can get caught up in,” Schur said, “this is one of the most disastrous.”

The Department of Labor, just one of four organizations that can come after parties that may run afoul of the classification, said in 2015 that it recovered $246 million in back wages. That number is in stark contrast to the previous year’s $79 million recovered, which could mean the Department is cracking down on the issue.

The Bureau of Statistics estimates that roughly 10 percent of the workforce (14.4 million people) is classified as independent contractors. However, the Department of Labor has an estimate of its own – roughly 3.4 million of them are misclassified and should actually be considered employees.

Value of “contractor”

The value of classifying someone as an independent contractor is that the employer is not paying taxes on those wages. Instead, the company that hires the independent contractor only has to pay the fee, wage or commission. There is no responsibility for paying overtime, vacation, payroll taxes, FICA, Social Security – that’s the responsibility of the independent contractor.

Another perk for the independent contractor is that the person can deduct mileage, expenses, etc. – anything that falls under the cost of doing business. That makes it an enticing proposition.

Enthusiasm should be quickly tempered, though, when considering the fact that if you wrongly bring someone in as an independent contractor, there are four government agencies that are going to potentially take notice, perform audits, and levy fines and penalties that can devastate your business.

“If they find that the misclassification was intentional,” Schur said, “that may qualify as a criminal offense and result in a prison term, plus tens, if not hundreds, of thousands of dollars in penalties and fines.”

The Internal Revenue Service is one agency that will get involved and hand down its monetary punishment. The Department of Labor can also step in, and the independent contractor who actually qualified as an employee is now owed back wages and overtime. Also, the state’s Department of Revenue can come in and collect back taxes. The state’s Department of Labor can also get involved and hand down its own fines and penalties.

“An independent contractor who is misclassified and should be an employee creates a huge liability to both the company and the contractor,” Schur said. “Huge liability.”

It’s a problem in the auction industry, Schur said, because so many contract bid callers work as independent contractors. Some will consider themselves independent contractors because they work for multiple auction houses. They may be legitimate contractors, but working for more than one company is just one of many indicators that they’re not an employee.

One of the most important aspects of this issue involves control. The company that hires contractors cannot control them like they would an employee. Schur said Auctioneers can demonstrate they may qualify as an independent contractor if they establish themselves as an LLC or other business entity – there has to be some business structure there, not just an individual.

Having insurance is recommended, and you must demonstrate that you are providing a skilled service to multiple clients. You should have the control to accept or reject assignments as you see fit. There should also be a contract between the contractor and the employer that specifically spells out that you are a contractor and not controlled by the company.

A true independent contractor will bring their own tools to the job, set their own schedule, and will bill the client instead of submitting a time sheet. Schur points to the IRS’s independent contractors 20-factor test to determine if you qualify as a contractor or an employee. However, he cautions that this is not a fool-proof method of making that determination.

“It’s guiding principles and nothing more,” Schur warns. “You’re always at the mercy of the investigator.”

In the 20-factor guidelines, the IRS says that if a worker performs services in the order or sequence set by the person for whom the services are performed, that shows the worker is not free to follow his or her own pattern of work, which indicates they are employees rather than contractors. However, investment in facilities, such as tools used on the job, would indicate that the worker classified as an independent contractor.

IRS Topic 762: Independent Contractor vs. Employee

The IRS weighs in on the issue with “Topic 762 – Independent Contractor vs. Employee,” saying that, “you should consider all evidence of the degree of control and independence in this relationship. The facts that provide this evidence fall into three categories – Behavioral Control, Financial Control, and the Relationship of the Parties.”

• Behavioral: Does the company control or at least have the right to control what the job is and how the worker does their job?

• Financial: Are expenses reimbursed? Are tools provided or does the contractor bring in their own? Are the business aspects of the job controlled by the payer?

• Relationship to parties: Has a contract been written describing the relationship? How permanent is the relationship? Does the business offer employee-type benefits?

For 30-plus years, Schur’s company hired an independent contractor to sell cars at an impound auction. The contractor came in with his own truck, microphone, experience, etc. The seller set the auction time, so Schur’s company was, in theory, in the clear on that account, too. However, he’s in no hurry to bring in outside help as a contractor if there is even the slightest doubt.

“Don’t gamble if you’re an employer,” Schur advises. “If you’re in doubt, make them an employee. It’s a heck of a lot cheaper than going out of business. When in doubt, contact your attorney or tax professional.”

*Ed. note – Prior to working in the auction industry, Schur earned his senior professional in human resources (SPHR) designation, and ran an HR consulting company.