Sub or Employee? The Legal Puzzle

A discussion of when you legally pay someone as a subcontractor rather than an employee. February 17, 2006

Question
I recently interviewed someone to work with me in my shop and he seems very capable. He told me he has workers comp and insurance. My question is, how do deal with this? If I hire him as an employee, do I also have to supply workers comp and etc, or do I treat him as a sub and pay him for his time only? This is my first employee. I've been solo for 16 years, so I'm rusty on these matters. Any help and advice would be appreciated.

Forum Responses
(Business and Management Forum)
From contributor B:
You could hire him as an independent contractor, but if he's using your equipment (and gets hurt) you could still be liable. I suggest getting an insurance binder from his insurer and have your insurance company or lawyer review it first. I rent commercial property and get binders from all my tenants. It's also not uncommon to request one from a roofer or anyone working on your property. If he really does have the insurance then there should be no problem producing a copy. A lot of people I know have gone over to hiring guys from temp services like Manpower and Labor Ready. You can get the same person every time and they take care of the payroll and insurance issues. It's a bit more per hour but it beats the hassles of dealing with the state.

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From contributor C:
I wouldn't take any chances with this one. Hiring a temp is a good option, but if you want to hire this guy, contact your state dept of employment security and they will give you a handbook outlining your obligations on all these issues. You also need to contact the IRS for the same reasons. They tend to show particular interest in companies hiring private contractors on a regular basis. You need to have all the facts straight from the horse’s mouth to make an informed decision.

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From contributor R:
Be careful. There are ways to do what you want to do but look into your state laws. A few years ago I used to carry my own workman’s comp and liability insurance and sub out to contractors. It can be done legally but there are a lot of ways to get snagged up and end up with a fine for the employer. Check with an accountant as well. Where I'm from it's not uncommon for an owner to carry insurance on himself.

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From contributor J:
If he is going to be working in your shop and presumably under your supervision and guidance he is not an independent contractor, according the local, state, and the fed government he is an employee. If he has verifiable workers comp insurance, that's fine. It doesn't matter who pays for it, but you do need it. You will have to withhold FICA taxes and match them, Fed and state income tax withholding, and state and Fed unemployment tax.

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From contributor D:
I have seen several shops get caught and close since they do not fit the IRS subcontractor definitions. The former owners will spend the rest of their lives paying the IRS. The shops that call them employees never have a problem. In fact, a couple of savvy nearby shops that know their numbers can tell when a shop full of "subs" is bidding the same work due to the difference in selling prices.

The IRS doesn't catch them until someone complains or calls it to their attention. Just because the IRS hasn't come knocking doesn't mean it is an allowed definition, your liability just increases - exponentially with penalty and interest. The obvious tell of course, is that every business in the US - from GM to H R Block - would change to subcontractors if the 1099 route was anyway near legit.

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From contributor E:
There is a lot of sound advice above about the fact that one is playing with fire if one tries to treat an employee as an independent contractor. It's not just the tax, penalties and interest which would wind up being due if the treatment is found to be improper, it's the fact that you as the owner of your sole proprietorship or officer of your corporation are personally liable for the tax, penalties and interest.

The IRS summarizes their rules thusly:
To determine whether a worker is an independent contractor or an employee under common law, you must examine the relationship between the worker and the business. All evidence of control and independence in this relationship should be considered. The facts that provide this evidence fall into three categories – Behavioral Control, Financial Control, and the Type of Relationship itself.

Behavioral Control covers facts that show whether the business has a right to direct and control how the work is done through instructions, training, or other means.

Financial Control covers facts that show whether the business has a right to control the financial and business aspects of the worker's job. This includes:
* The extent to which the worker has reimbursed business expenses,
* The extent of the worker's investment in the facilities used in performing services,
* The extent to which the worker makes his or her services available to the relevant market,
* How the business pays the worker, and
* The extent to which the worker can realize a profit or incur a loss.

Type of Relationship includes:
* Written contracts describing the relationship the parties intended to create,
* The extent to which the worker is available to perform services for other, similar businesses,
* Whether the business provides the worker with employee–type benefits, such as insurance, a pension plan, vacation pay, or sick pay,
* The permanency of the relationship, and
* The extent to which services performed by the worker are a key aspect of the regular business of the company.

Consult a competent tax professional before proceeding. Mistakes in this area can be very expensive.