By Eric Bass

Small business owners are always seeking ways to simplify operations and reduce costs. One option they often consider is treating workers as contractors instead of employees. However, incorrectly classifying workers as independent contractors instead of employees can expose businesses to serious legal and financial consequences, including back taxes, lawsuits, and personal liability for unpaid taxes. While the cost savings associated with independent contractors are tempting, business owners must understand the significant risks involved before making classification decisions.

Potential Employer Cost Savings of Independent Contractors

Deeming a worker an independent contractor can save business owners substantial costs, including:

  • Employer portions of FICA taxes (7.5% of gross pay)
  • Unemployment compensation taxes
  • Workers’ compensation insurance
  • Benefit costs such as health insurance, paid time off, and retirement plans

Certain industries, such as transportation and delivery services (e.g., DoorDash or Uber), may also save on equipment, maintenance, and training expenses by using independent contractors.

Considerations for the Independent Contractors

Independent contractors shoulder additional obligations and costs, including:

  • Paying self-employment taxes (approximately 15% of gross income)
  • Handling quarterly estimated taxes
  • Providing their own tools, equipment, and insurance
  • Foregoing employer-provided benefits

As a result, contractors often negotiate higher gross compensation to cover these additional expenses. Nonetheless, many business owners still find contractor relationships financially advantageous.

Business Owner Risks for Misclassification

Business owners must recognize that they do not have the final say in worker classification. The IRS and other government agencies independently evaluate these relationships, regardless of any agreement between the business and the worker.

If the IRS determines that workers were misclassified, business owners face:

  • Liability for back taxes
  • Penalties of 20% to 40% of unpaid amounts, plus interest
  • Potential personal liability, even if operating through a corporation or LLC
  • Retroactive responsibility for the workers’ share of FICA taxes

Making the Proper Classification Decision

There is no simple test to determine proper classification. Instead, the IRS considers the “totality of the circumstances,” focusing on three main categories:

  • Behavioral Control: Does the company control or have the right to control what and how the worker performs tasks?
  • Financial Control: Does the business control the economic aspects of the worker’s job?
  • Type of Relationship: Are there written contracts? Are benefits provided? Is the work integral to the business? Is the relationship ongoing?

Key factors include:

  • Degree of instruction and training
  • Integration into business operations
  • Authority to hire and supervise assistants
  • Flexibility in setting work hours
  • Requirement to work on premises
  • Method of payment
  • Provision of tools and equipment
  • Freedom to provide services to others
  • Termination rights and penalties

Even if multiple factors suggest independent contractor status, a few key elements could tip the scales toward employee classification. Each situation must be evaluated individually.

The Importance of Legal Counsel

Given the complexity and high stakes involved, business owners should always seek experienced legal counsel before classifying service providers. An attorney can:

  • Analyze specific worker relationships
  • Recommend necessary adjustments to job structures
  • Prepare clear, accurate employment or contractor agreements
  • Help build a strong record for potential IRS or legal challenges

Written agreements alone are not decisive but can serve as important evidence when accurately reflecting the working relationship.

Protect Your Business — Consult Venn Law Group

The attorneys at Venn Law Group have extensive experience guiding business owners through worker classification and employment matters. Contact us today to ensure your business is protected and compliant.

Eric Bass holds both a JD and an MBA, providing him with a wealth of knowledge and insight regarding the challenges business owners face. His practice focuses on helping business owners understand, assess, and best address business risks, resource allocation, and reachable goals. Eric also helps his client business owners prosper and grow by connecting them with other advisors who can help them move forward. Practice areas: contracts, mergers and acquisitions, succession and exit planning, and employment issues for employers.