6

I read on the Workplace SE people mention being full-time employees employed as independent contractors. What would be the legal consequences of doing so?

I'm under the impression that contract work and full-time employment are taxed differently. The IRS may take offense to the misrepresentation of employees in that manner. There may also be labour laws that prevent this.

There is also the issue of a business that can learn to rely on workers who can, after a certain amount of time, just walk away with no notice. Nickle-and-diming the wage bill has its consequences in that regard as well, but this question is more interested in legal consequences.

2
  • 8
    Confusion is arising over terminology. The choice is hiring a person as an employee vs independent contractor with emphasis on the independent. Hiring somebody "with a contract" is imprecise.
    – user71659
    Apr 12 at 20:16
  • @user71659 thank you for that, I have made an edit.
    – Neil Meyer
    Apr 14 at 15:57

3 Answers 3

13

A worker can be a contractor or an employee

But what's important is the contract, not what you call them

Determining if a contract is an employment contract relies on a multi-factor test used in most common law jurisdictions. The factors are not exhaustive and no factor is determinative but include:

  • the extent of control of, or the right to control, the worker;
  • the express terms of the contract between the parties;
  • whether the worker was provided with tools and equipment;
  • whether uniforms were provided and / or required by the company;
  • whether the worker was permitted to delegate or subcontract work;
  • the remuneration structure - specifically, whether the individual received payment of a periodic wage or salary or compensation by reference to the completion of a task or project;
  • whether the worker was entitled to paid annual leave or sick leave.

Labels (e.g. 'employee' or 'contractor') used by parties in contracts to describe their relationship are not determinative or often even relevant to determining whether an employment relationship exists: CFMEU v Personnel Contracting Pty Ltd [2022] HCA 1 at [63]-[66], [79], [86], [184].

The task for a court is to identify whether the 'totality of the relationship' between the parties, as embodied in the contract reflects an employment relationship: CFMMEU at [61].

In , this crystallises when the contract is entered. Where the parties are not contesting that the contract was a sham or was effectively renegotiated, subsequent behaviour during the execution of the contract is irrelevant. That is, you are either a contractor or an employee when you enter the contract, and this does not change. In other jurisdictions, the court may look at the contract as performed to make the determination.

There is no problem with engaging employees, contractors, or both. The problems come if you have misclassified them

Misclassification

First, you can't misclassify a contractor as an employee - treating a worker as an employee is determinative because withholding tax, paying superannuation, paying leave, etc., ticks so many factors that the person is definitively an employee. The problems come when an employee is misclassified as a contractor.

Here are some examples of problems that may occur. For employees:

  • There is a national minimum wage. In addition, most employees are covered by Awards that set higher minimum wages for particular jobs (e.g. plumber, hairdresser, scientist, etc.);
  • The minimum wage must be paid in cash. While contractors are usually paid in cash, you can enter quid-pro-quo contracts or other non-cash arrangements with contractors that would be illegal for employees. Non-cash payments to employees are allowed above the minimum wage, but they are subject to Fringe-Benefit Tax, which you probably didn't pay;
  • You must withhold tax from wages and remit it to the Australian Tax Office. If you have misclassified, the amount you paid to the employee will be considered net wages, leaving you on the hook for the tax. Oh, and penalties and interest for late payment of it;
  • You can't get a Goods and Services Tax credit from an employee. So, the amount you claimed for the misclassified employee must be repaid. With penalties and interest;
  • You need Worker's Compensation Insurance for employees. And also for some types of contractors. But, even if you did pay what you were supposed to for a contractor, the amount is probably different if they were misclassified - because of that nett-gross-tax thing mentioned above. There are penalties and interest on this, too.
  • Ditto, superannuation.
  • Oh, and that misclassified employee you've had for 12 years? You owe them 12 years' worth of public holiday, annual, sick, and long service leave pay. You also committed wage theft for not paying it when it was due.
  • You may have dismissed them unfairly, leaving you liable to pay compensation - an employee has more rights than a contractor.
  • If you required them to undertake training or pay for safety equipment, you need to reimburse them for that - employer's are responsible for that, principal's aren't.
9
  • 1
    I totally forgot that full-time employees also have work contracts. So technically speaking almost all forms of employment is done on contract basis as far as it is employment involving a contract. Maybe a contractor is a better term.
    – Neil Meyer
    Apr 12 at 9:24
  • 1
    Every time I read about employment law in other countries I thank my lucky stars for living in the US where everything is much more simple. Apr 13 at 3:41
  • 7
    @JonathanReez the US has the employee/contractor distinction too; it’s just that employees have far fewer rights and protections there.
    – Dale M
    Apr 13 at 4:03
  • 1
    Yes, even the US is not perfect but sadly there isn't a less regulated nation out there. Apr 13 at 4:05
  • 2
    @JonathanReez There are plenty of less-regulated nations out there. Somalia is just one example. You should check into it and see if you want to move there!
    – cjs
    Apr 14 at 9:56
10

If someone is being a full-time employee, they legally are an employee (with all the tax etc. consequences). The fact that the company thinks they are hired "on contract basis" and deems them contractors while still treating them like employees changes nothing to their employee status.

The burden of establishing that a worker is a contractor is on the company. There is a test for this called the “ABC test” (established in Dynamex Operations West, Inc. v. Superior Court) which is used to tell contractors from employees:

(A) that the worker is free from the control and direction of the hiring entity in connection with the performance of the work, both under the contract for the performance of the work and in fact; and

(B) that the worker performs work that is outside the usual course of the hiring entity's business; and

(C) that the worker is customarily engaged in an independently established trade, occupation, or business of the same nature as the work performed.

In a nut shell, being a true contractor means that the company is the worker's client, not an employer. If they keep bossing a worker around while reporting them as a contractor, they are potentially liable for fines/penalties.

1
  • 4
    It should perhaps be mentioned that the ABC test is the test for California, not everywhere. Even in California, it is subject to limitations under Proposition 22.
    – Kevin
    Apr 12 at 21:06
1

Some of the legal consequences

Upon further research, I would like to add more about the legal ramifications of miss-classification. Other answers have done a good job of what makes an employee an employee and what makes them a contractor. I want to address the legal consequences of doing it wrong.

Misclassification penalties depend on several factors including the size of the company, the amount of time the misclassification was in effect, and whether the Department of Labour considers the incorrect classification to have been intentional.

Tax Violation Fines:

If the IRS conducts an audit and finds a miss classification the business could face fines including

  • Up to 3% of the employee's wages
  • 100% of the FICA taxes not paid
  • Up to 40% of back taxes
  • 50% per W-2 tax form that was not filed wages.

Misclassification also violates employee's federal protections regarding minimum wage and benefits. The Department of Labour takes these issues very seriously. At a minimum back wages may be paid but criminal penalties can also be imposed, which may include.

  • Payment penalties of up to a 1000$ per employee
  • Jail time of up to 1 year
  • Class Action Lawsuits
  • Benefits insurance repayments
  • Additional audits looking for other irregularities
1
  • This is why there's a big issue over whether gig workers (e.g. Uber/Lyft drivers) should be classified as employees or independent contractors.
    – Barmar
    May 21 at 17:46

You must log in to answer this question.

Not the answer you're looking for? Browse other questions tagged .