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Employment Verifications

The Dangers of Treating Home Operators as Independent Contractors

November 07, 2013

By Attorney Les Rosen, Founder and CEO of Employment Screening Resources (ESR)

Many screening firms feel they have overcome the economic and production challenges associated with employment verifications by using at-home workers. It can be cost effective because the at-home workers get paid on a per order basis without the necessity to pay a salary or benefits. The screening firm can use them on an as-needed basis, so that the screening firm is not burdened with more people on payroll than needed at any given time.

In the typical scenario, the screening firm treats the at-home workers as independent contractors, which means they are not on payroll, but only get paid on a piece rate basis when they are utilized. They must follow the screening firm’s exact procedures. The screening firm often has regular employees at the main office doing the same work, so that the so-called “independent contractors” are doing what regular employees do, but without a regular salary, or any benefits.

At-home workers typically provide services to only one screening firm. They do not offer their services to other firms. At-home workers typically do not have business cards, their own insurance, yellow page ads, a business license or any of the other attributes of a true independent business.

For screening firms, there are obvious financial and tax advantages to utilizing home workers as independent contractors to perform verifications:

  • First, a screening firm can obtain services at a predictable fixed rate, no matter how much work is performed. This represents an advantage over hiring employees who must be paid no matter how fast or slow they work, or how much work there is to be done.
  • Second, a screening firm can avoid the payroll costs associated with employees, such as paying workers’ compensation insurance premiums, unemployment insurance, withholding taxes, or paying the employer share of payroll taxes.
  • Third, the screening firm avoids paying benefits, such as paid holidays, vacation, health or retirement.
  • Fourth, a business avoids the problems associated with managing employees or handling employee recordkeeping.
  • Fifth, an employer can attempt to insulate itself from the potential liability it can have with employees, such as exposure for discrimination lawsuits, or wrongful termination.

With all of these advantages, it would seem that using at-home independent contractors for verifications is a savvy business move that makes complete business sense.

However, as the old saying goes, when something is too good to be true, it may not be true.

Simply put, the advantages enjoyed by a business in classifying a worker as an independent contractor are disadvantages for the Internal Revenue Services (IRS) and state agencies that administer tax collection programs. The IRS has an interest in businesses putting workers on payroll to better ensure the collection and withholding of payroll taxes. States want employers to pay workers’ compensation premiums and unemployment insurance. As a result, the IRS and the states have a big stake in ensuring that businesses do not misclassify a worker as an “independent contractor” when in fact they should be on payroll.

The IRS and state agencies have the authority, which they exercise, to conduct extensive audits of a business to determine if the classification was correct. If the IRS or state agencies determine that workers should have been classified as employees, then the business can be subject to fines, penalties, back taxes, and lawyer’s fees.

How does the at-home worker make an employer the subject of an IRS or state audit? There are a number of ways:

  • An at-home worker gets injured and files for workers’ compensation benefits. The business claims that the worker was in fact an independent contractor. At that point, the claim can trigger an audit of all business practices related to independent contractors. Failure to have workers’ compensation in place is unlawful and has extremely serious consequences for businesses.
  • A worker decides they no longer want to do verifications, and they file for unemployment insurance benefits and lists the screening firm as the last employer. When the state shows no record of employer contributions, an audit may be triggered.
  • An at-home worker files a discrimination claim.
  • An at-home worker feels they are doing the same work as employees but without the benefits, and they file a claim or even a lawsuit for benefits. This happened to Microsoft, when so-called independent contractors sued because they were doing the same work as employees, but not getting benefits or stock options.

The bottom line is that even though at one time the at-home worker wanted the opportunity to work from home, if the relationship goes sour for any reason, a business is now essentially at the mercy of their former at-home worker who can trigger a very expensive audit that can have significant financial repercussions for a screening firm.

What happens if the audit results in a finding that the business was essentially “cheating” by misclassifying workers as independent contractors instead of employees? The consequences of misclassifying employees as independent contractors can be substantial.

The IRS or state may flag the business for an audit of how it classifies all of its independent contractors. The auditing process can be extremely time consuming and expensive. Some employers have had the experience of government auditors literally setting up shop for extensive periods of time in their offices during the auditing process. If the audit reveals that there were others who were wrongly classified, the financial consequence could be enormous.

As a result of trying to avoid treating at-home workers as employees, a screening firm can potentially face:

  • Liability for all federal and state payroll taxes that should have been paid for all misclassified workers.
  • Interest, fines and penalties to the IRS or state. Penalties can be substantial.
  • Costs, and attorney’s fees, and compensatory and punitive damages if litigation is involved.
  • Benefits the workers would have received if classified as employees, including vacation, health, paid holidays and retirement.
  • Overtime pay under the Fair Labor Standards Act and comparable state laws if the hours he or she provided to the contracting party in the past exceeded the standard workweek.
  • Unemployment claims.
  • Extending any stock option plan the worker would have had if they were properly treated as employees.

In other words, to try to save some money now, a screening firm that tries to use at-home workers as independent contractors incorrectly, not only may have to make up all of the past costs they thought they were saving, but they may have to suffer through an extensive audit and pay substantial back taxes, benefits, penalties and legal fees.

Whether a worker is in fact an independent contractor or an employee depends upon the application of various tests. The IRS utilizes a 20 point test. In some jurisdictions, courts and state agencies may use variations of the IRS test or various other tests.

In applying the various tests, there are three things to keep in mind.

First, the most important consideration is whether the at-home worker is truly an “independent” person running their own business or just an employee in disguise. The courts focus on the degree of control. For a worker to be classified as an independent contractor, he or she must be both physically and economically autonomous of the employer.

The second consideration is that the independent contractor test is not a mechanical application of the rules—some employers make the mistake of reviewing the list as a scorecard and coming to the wrong conclusion. It can be extremely difficult to predict what the IRS or state will conclude in any given situation. The law of proper classification of workers is very complex and normally requires the assistance of a lawyer or CPA.

Finally it is irrelevant what the parties chose to call themselves. Courts, the IRS and state agencies are not influenced at all by a written piece of paper that some worker signed alleging they are independent.

Without going into a full discussion of all of the factors used by they IRS, state agencies and courts, an employer attempting to justify classifying an at-home worker making calls as an independent contractor has a substantial uphill challenge. Here is why:

  • At-home workers are under the direction and control of the screening firm in how and when the work is accomplished.
  • At-home workers are doing the same thing that in-house employees do.
  • At-home workers must submit regular reports to the screening firm.
  • At-home workers must often follow an established schedule in order to coordinate their tasks with in-house employees.
  • The work being performed is a part of the core business of the screening firm.
  • The at-home worker typically has an exclusive relationship with the screening firm.
  • The worker receives financial payments at set intervals in what amounts to the equivalent of a regular paycheck based upon volume of work
  • The worker has none of the attributes of a true “independent” business, such as a business license, yellow page ads, insurance, a web site, membership in a chamber of commerce, or so forth.

The lesson: Not only does the use of at-home workers for verifications expose a screening firm to liability for issues surrounding privacy, security and FCRA compliance, but attempting to avoid having them on payroll in order to save money is a game of Russian Roulette. It only takes one so-called independent contractor to trigger a government examination of a firm’s practices, creating a tremendous potential liability. At that point, the money a firm thought they were saving by paying at-home workers as independent contractors may not look like such a clever business move after all.

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