Perhaps it wouldn’t have been so annoying if we weren’t “doing good” by having the intern work at our firm a few days a week perhaps two decades ago.
Since he is now a judge in Northern California, the internship couldn’t have done much harm to his introduction to the practice of law. But it sure provided a brutal lesson to us perhaps two years after he had finished his internship and was back graduating from law school.
Jerry (not his real name) was working his way through law school in San Francisco, had two-part time jobs, but during the summer break asked if he could spend a couple of days working in our office to get the feel of what the practical practice of law is about.
“I want to see what it’s like in the trenches,” he said, crossing his legs nervously as he sat across my desk on a very foggy summer morning. He had carefully dressed in a rather faded suit and had done a pretty good job tying a very ugly tie.
I leaned back in my chair. “What it’s like in the trenches? Trenches are channels in the ground. It’s dirty in a trench.”
He laughter was a bit forced.
I went on. “What we do here has little to do with the study of appellate law you encounter in law school, Jerry. What we do here is sell power to people who need it and, sometimes, justice as well. Fighting against people just like us. This is the only profession where your competitors do not just compete, but are paid to directly confront you and make you lose. It’s war….”
“That’s why you’re in trenches, then. Makes perfect sense. Guess I want to see what it’s like in the mud and blood.”
I grinned at his answer That type of quick response in a nerve wracking interview demonstrated the type of quick mind that his chosen profession required. We hired Jerry as an independent contractor, working two days a week and getting training more than just working, the attorneys enjoying working with this enthusiastic neophyte.
And he was just as good as we hoped during that summer. Two cases that should have settled escalated into outright scorched earth litigations, one because a family went to war instead of being sensible and the other because our opposing counsel wanted to demonstrate his manhood by refusing a mediation and, instead, demanding a dozen new depositions within ninety days of trial.
Jerry met the challenge, working long hours, excited and enthusiastic, becoming a valuable part of the legal team, coming up with new insights that we jaded lawyers failed to recognize. We increased his rate of pay accordingly and he was making good money for his hourly work by the time summer drew to a close. He had to go back to law school and we regretted his leaving. He wrote a note a few weeks after he was back in class, thanking us and stating the following: “I was afraid that law would end up a boring exercise of arcane exchanges of legal theory. You people showed me it’s about people. We help people and the law is the tool we use. I will never forget that.” All our attorneys glowed.
Perhaps two years later the State of California hit us with a very large tax bill. We had treated him as an independent contractor, not an employee. That meant we did not withhold for him, did not put him on our pension plan or medical plan, did not pay overtime or vacation time, etc. He was a student spending a few months with us, merely paid for the hours he put in. We considered him a contractor.
And the bill was so large because perhaps 40% of the cost of an employee cost is fringe benefits, matching payroll taxes withheld, plus interest and penalties.
We were outraged. We did not hire him to be an employee. He was the very definition of a part time contractor, working other jobs, coming in to cover unusual situations. But the State had analyzed his hours, determined that he had actually quit one of his other two jobs and defined his commitment as one of a part time employee working sufficient hours to require full withholding. Not only did they insist upon the payments due, but wanted interest and penalties. Rather than spend thousands of dollars appealing their decision, we simply paid. So would you.
In determining if someone is an employee or independent contractor, different agencies apply different criteria and courts disagree on the criteria that will be used. However, in general, the following factors are important in determining whether a worker is more correctly classified as an employee:
Whether the worker can be terminated at will;
Whether a manager (or designated person) assigns, reviews, and supervises the worker’s work product.
Whether the worker performs services that are a part of the regular operation of the business.
Whether the worker has other customers of his or her services;
Whether the worker provides his own tools or locale for work;
Whether the worker was formerly an employee of the company;
Whether all or substantially all the worker’s time is allocated to the company’s business;
Whether the parties have executed an appropriate written agreement providing for delivery of services and providing that the worker is an independent contractor.
Different jurisdictions apply slightly different criteria but one thing must be kept in mind: in every instance, more money goes to the jurisdiction if it classifies the person as an employee. To establish someone is an independent contractor can be an uphill battle in which you pay for your own attorneys and CPAs to argue with a state or federal agency with their professionals on payroll.
The cost to an employer in failing to correctly classify an employee can be a violation of various Federal and State statutes that apply to companies of a certain size, as well as a failure to withhold sufficient taxes and other benefit payments. Interest and penalties can be imposed and they can be substantial. The employee may also face tax liability.
Employers are not required to withhold taxes from independent contractor earnings. Instead, they file information returns to the Internal Revenue Service and state authorities, indicating the amount paid in wages to the independent contractor. This information is also provided to the contractor on IRS Form 1099-MISC. The Internal Revenue Code and various state laws impose substantial penalties on employers for improper classification of employees as independent contractors.
Likewise, the Code imposes penalties and fines upon independent contractors who either fail to report income or who do not file self-employment quarterly returns. Additionally, the independent contractor must back-pay all taxes and social security deductions accrued during the misclassified period, in addition to those currently due.
Penalties to employers for failure to withhold income taxes are generally equal to 1.5 percent of the wages, plus 20 percent of the social security and Medicare taxes that should have been paid by the employee. There is also a liability for the unpaid portion of the employer’s portion of the social security and Medicare taxes.
Assuming the employer failed to conform to Federal statutes (employee family leave and the like) additional fines and penalties may apply and these could be retroactive to the time the number of employees was found to exceed the minimum limit.
It should be noted that the liability may apply even if the independent contractor is obtained through a service company. Companies also may be liable to temporary workers who are employed through third parties (such as personnel agencies). Case law holds that the personnel agency is generally deemed to be a nominal employer and the end-user company is the true employer. In the alternative, some jurisdictions have found that both are joint employers of the worker. In either case, the company faces liability.
Certain states, such as California, are noted for the aggressiveness of their enforcement procedures and have been known to classify temporary student interns as employees requiring withholding and the other fringe benefits. Companies routinely impose a time period before certain benefits accrue, such as health and pension, but other aspects, such as withholding, must be performed immediately.
In our case, we were lucky; the cost was minor and the timespan in which Jerry worked for us was limited to two months during the summer. He was the only person so classified and from that point onward we classified all part time law clerks as part time employees.
But a client who provided workers to the electrical contracting industry was not so lucky, with fifty or more such contractors retroactively classified as employees, many of whom had disappeared from the State by the time the audit occurred. It destroyed her business.
This is often not a question of worker versus employer so much as the government versus both since it is the government, seeking taxes, that is usually the party insisting upon payment. Unions and labor groups bemoan the fact that independent contractors are actually forced to comply with the company insistence that they are not employees and such undoubtedly does happen. Just as often, in our experience, both the worker and the employer are outraged by the efforts of the government to seek payroll taxes, etc. and to reclassify the relationship to the extra expense of the parties.
But in this time of tax shortfalls, it can be expected that scrutiny will be increased by the various governmental agencies and the wise company or contractor will take the time to ensure that they actually meet the criteria for the appropriate classification of their relationship.
And, remember, it does not matter what you and the worker want or think…UNLESS you create the right working environment, the right contract, and ensure that the worker does not alter his or her working relation with others during his or her tenure. You may end up with an employee whether you knew it or not.