To W-2 or Not To W-2?

To W-2 or Not To W-2?

That is, indeed, the question for burgeoning technology companies – whether to hire permanent employees or independent contractors.

It’s a common decision faced by startups that don’t have much cash on hand and could have changing personnel needs as the company evolves. Instead of hiring employees and incurring the related costs of recruiting, hiring, training and providing benefits (not to mention the tax obligations), some firms will bring in freelancers on a per-job basis or for a limited timeframe. This allows them to adjust their workforces appropriately as personnel needs become clearer, as well as save any reserve funds for investment in the company itself.

Which is the better choice for you?

This prevalence of independent contractors has become known as the “gig economy,” and it has grown exponentially. In 2014, Forbes estimated that roughly 34 percent of Americans were freelance workers – a number that is expected to increase to 50 percent by the year 2020. Independent/temporary contractor use provides a less expensive and more scalable employment solution for companies as they grow; employers are not required to withhold income taxes, withhold/pay Social Security and Medicare taxes, and pay unemployment taxes on wages paid to these workers. It also means greater flexibility for those who are hired, since they’re not usually committed to specific hours and generally have fewer restrictions on their own operations and behavior.

There are also benefits, however, to hiring official employees. A company has the right to control certain factors of how an employee behaves, from what they wear to how they interact with clients. This makes for a more professional image and cohesive brand for your company, which in turn increases legitimacy. And since they’re more likely to stick around than independent contractors, it’s easier for each employee (and as a result, your company) to build long-term relationships with your customers. Employees also benefit, as they’re generally offered health insurance, paid time off, retirement and other perks of being on a permanent staff.

So the choice you make here depends upon your ability to support permanent employment with regards to both workload and ability to compensate your staff. Whichever choice you make, however, be sure that you classify them properly.

The Importance of Correct Classification

Freelancers’ popularity remains strong, but this arrangement can also lead to misrepresentation. Sometimes employers want the benefits of permanent workers, but they instead hire freelancers to avoid the tax obligations of regular staff (while still subjecting these workers to regular employment restrictions).

The consequences of such actions can be steep. In the 1990s, Microsoft intentionally misclassified thousands of temporary workers as independent contractors, even though some of them had worked for the company for years and even participated in the company’s employee stock purchase plan. The employees sued, and the technology giant was eventually made to pay $97 million in penalties and legal fees. Additionally, the Wage and Hour Division of the Department of Labor conducts investigations to uncover instances of misclassification; in fiscal year 2015 alone, their work resulted in more than $74 million in back wages for over 100,000 workers across the country.

How can I make sure I’m classifying my workers correctly?

This can get complex, with the DOL, the IRS and the National Labor Relations Board each having their own rules. However, the basic “common law” standard defined in 1948 focuses on whether the employer is “legally responsible for the acts or omissions of” the worker. The IRS takes it further to encompass three areas of examination:

  • Behavioral control – Who possesses the right to direct or control how the worker performs tasks?
  • Financial control – Who possesses the right to direct business aspects of the arrangement, such as reimbursement terms, availability of the worker to other clients, etc.?
  • Relationship – How do both parties perceive the relationship, whether the worker receives benefits, the terms of termination, etc.?

So how can you make sure you’re in compliance? The first step is to ask yourself several questions about the arrangement, such as:

  • Does your company pay for the worker’s resources (tools, computer equipment, internet access, etc.)?
  • Are specific hours/shifts designated by your company for the worker?
  • Is the worker required to perform tasks on company premises?
  • Do you set specific procedures or instructions on how work is to be performed?
  • Is company approval required if the worker brings on more people to assist him/her in the work?
  • Is the worker required to work full-time hours for your company?
  • Do you pay the worker based on time increments instead of by jobs completed?
  • Does your company pay for business/travel expenses?
  • Does your company require written or oral reports from the worker?
  • Does your company demand exclusivity from the worker (i.e., he or she cannot perform similar work for another firm)?
  • Was this worker once an employee but was then “converted” to an independent contractor (but with the same general responsibilities)?
  • Can you terminate the contract at his or her discretion without a violation on the worker’s part?

If you answer yes to any of these questions, it’s possible that the government would see your independent contractors as actual employees – putting you at risk for lawsuits and steep financial penalties.

To make sure you’re providing a fair and equitable situation for both you and the people working for you, contact a business consultant, human resources consultant or employment attorney. He or she can review the work arrangement and advise you of any steps necessary to ensure that everyone is classified correctly.

All content provided in this article is for informational purposes only. Matters discussed in this article are subject to change. For up-to-date information on this subject please contact a James Moore professional. James Moore will not be held responsible for any claim, loss, damage or inconvenience caused as a result of any information within these pages or any information accessed through this site.