The desire to create jobs is a big driver for would-be entrepreneurs. Too often, though, new business owners fail to learn the legal responsibilities that come with hiring employees. Knowing whether to report a worker as an employee or contractor is one of the most significant yet least understood of these responsibilities.
To help new entrepreneurs avoid the tax penalties and fines that can come with worker misclassification, I spoke with Robert Colby, a Highland Park-based attorney who specializes in small businesses. Our conversation yielded a quick guide to correctly classifying workers:
When a business owner hires an employee, she takes on a fair amount of responsibility. For example, she must pay a portion of the unemployment and social security insurance the employee owes, and she is subject to regulations of the Occupational Safety and Health Administration.
When she hires an independent contractor, she avoids the unemployment and social security charges. And because it’s assumed the contractor works from outside her office or facility, she can avoid OSHA regulations.
Basically, classifying a worker as an “independent contractor” makes for a work arrangement that’s easier and cheaper for the employer. It should surprise no one, then, that employers often attempt to apply the “independent contractor” designation to workers that ought to be considered full employees.
While many employers were getting away with this for a time, Colby said, the days of misclassifying with impunity are over. “Various labor departments found this tacitly acceptable, but in recent years, they have really started to crack down,” he said, adding, “Overall, the default in most situations should be full employment.”
The State of New Jersey uses a three-part, “ABC” test to determine if an independent contractor designation is valid, Colby said:
First, the worker must be free from “control and direction” of the performance of the job. “If the employer will be telling the worker how many things to produce or how many hours to work, they will fail the first part of the test,” Colby said.
Second, the nature of the supposed contractors work must be outside of what is normally happening in the business, Colby said. “Let’s say you have a cupcake factory; if the worker is going to be making cupcakes, you will immediately fail test B,” he said.
Third, the worker must be engaged in an independent occupation. “Essentially, the worker must have a business of their own,” Colby said. He said that while the employer need not know for sure whether the worker is engaged with multiple clients, there must be some understanding that once the worker’s contract with one business expires, he will continue doing the same type of work for other businesses.
For entrepreneurs inclined to pinch pennies (not a bad inclination, by the way) reporting workers as contractors is tempting. But failing to follow state reporting guidelines can cost business owners dearly. To learn more about the legal responsibilities of small-business ownership, contact Colby at Robert.Colby@RobertColbyLaw.Com.
