Is Your Worker an Employee or an Independent Contractor: Why it Matters

Determining whether your current staff and next hires are employees or independent contractors is not an exact science. We can help clarify this determination by explaining the tests that will help you decide whether a worker is an employee or an independent contractor and the implications of both.

Why Does Classification Matter?

Knowing if you have an employee or an independent contractor is important for a variety of business and compliance issues. Many business issues such as Federal and state taxes, employee benefits, ERISA compliance, and civil liability, hinge on whether or not a person is an employee or an independent contractor. For example, generally, your company is responsible for any liabilities caused by an employee, but not by an independent contractor. Likewise, for employees, your company is responsible for paying the employer portion of Social Security, Medicare and sometimes state unemployment taxes.

Misclassifying a worker can lead to a host of unwanted issues including penalties, taxes and fees. Therefore, knowing whether a worker is an employee or independent contract is important. Additionally, knowing these tests can help you properly classify a worker in the beginning of your relationship avoiding any repercussions of misclassification.

How Do You Know?

Three major categories are used to help determine the difference between an employee and an independent contractor: (1) behavioral factors, (2) financial factors, and (3) the nature of the relationship. No one factor is dispositive; instead, it is a weighing of several points in each category.

Behavioral Factors

Behavioral factors include the type and degree of instructions given, the measure used to determine a completed job, and the amount and duration of training. The more instructions and the more details given, the more likely the worker is to be classified as an employee. If you tell the worker when and where to do the work, which equipment or tools to use, where to purchase any supplies, what steps to take to complete the work, and which people should perform which tasks, then most likely this is an employee. The key factor is determining if the business has the right to control the details of the worker’s performance, even if little or no instruction is necessary.

How you evaluate the job after completion is also a factor. If you measure how the work was done, instead of the end result, this evaluation system suggests you have an employee. Training the worker on how to do the job also suggests that a worker is an employee, particularly if you have continual training or more than one training session.

Financial Factors

Financial factors tend to be a little trickier to evaluate because these factors cannot be applied across all types of services. For example, one factor that tends to show that a worker is an independent contractor is significant investment in the tools or equipment that the worker uses. However, this factor is not quantifiable; meaning, no dollar minimum qualifies as a “significant investment”. Additionally, some jobs, particularly in construction, where a worker buys his own tools, are still classified as employee positions.

Other financial factors that suggest a worker is an independent contractor are (1) unreimbursed expenses, (2) opportunity for profit or loss, (3) ability to seek out other business opportunities in the market, and (4) payment based on a flat fee per job, rather than payment on an hourly or salary basis. For example, independent contractors will typically have their own overhead costs, such as tools, equipment, insurance and other unreimbursed expenses. Thus, an independent contractor has the potential to lose money on a job; while an employee does not have this same risk.

Nature of the Relationship

The nature of the relationship refers to the interactions between the worker and the employer. Several factors can be weighed to determine the nature of the relationship, such as written employment contracts, employee benefits, the permanency of the relationship and whether or not the services provided are a key activity of the business. A written contract outlining the worker’s expectations and duties is helpful for making a determination on the type of worker; however, if your company has a worker that meets all of the factors for an employee, you cannot call them an independent contractor in their contract to avoid the employee classification. Likewise, if your company provides the worker with vacation pay, health insurance and a retirement plan, you are suggesting that the relationship will be ongoing, rather than specific to a project or predetermined period. Not providing workers with benefits does not mean they are independent contractors rather than employees.

You should also evaluate the services that the worker provides to your business. If the services are a key aspect of your business, this suggests the worker is an employee. For example, if you own a painting company and hired a worker to work at your office, answer phones calls, book appointments, handle client complaints and reorder office supplies, then this individual is an employee. On the other hand, if the computer system failed and you hired somebody to repair the system, you likely hired an independent contractor. The first worker is necessary on a long term basis to make sure that the company’s primary business runs smoothly, while the second worker is needed to complete a one-time project.

Summary

No one factor will determine a worker’s status and no specific number of factors will automatically classify a worker as an employee or independent contractor. Instead, evaluate each factor as a piece of the whole and look at the entire employment relationship. If after careful evaluation you are still unsure of a worker’s status, for tax purposes, you can seek a determination from the IRS using Form SS-8, available at the IRS. A determination from the IRS can be a lengthy process.

In addition to independent contractor and employee classifications, for tax purposes, workers have additional classifications for statutory employees and statutory nonemployees.

When to Use a Texas Shoot-Out: Resolving Partner Deadlock

Business partnerships are hard. What if you and your business partners couldn’t get along? Or, what if you and your business partners couldn’t agree on a major business decision resulting in deadlock? How do you move past such a roadblock? A company’s well written operating agreement or buy-sell agreement should address these concerns. One possible solution to these potential issues is the “shotgun clause”, also referred to as a deadlock provision or a “Texas shoot-out”.

Although varying methods can break up a deadlock, a common method is a Texas shoot-out provision which states that an owner has the option to either (1) buy out the other owner or (2) be bought out and exit the business. A shotgun clause essentially operates as an “I cut, you choose” method. In this scenario, two individuals can agree to share a piece of cake by having one cut the cake and the other choose his piece. Likewise, in a deadlock situation, one owner sets the price for the company and “cuts the cake”, while the other owner “picks the piece of cake” and decides whether to buy or sell his ownership in the company. Specifically, the owner being presented with the offer has the option of either accepting the offer and selling his interest or purchasing the other owner’s interest at the same price.

In theory, the Texas shoot-out is an easy way to settle disputes and offer clarity during an impossible situation. In reality, it could lead to abuse by the owner with the most money. For example, if one owner was cash poor or otherwise did not have easy access to capital, the owner with more capital could simply set an offer price that the cash poor owner could not meet. The outcome could force an owner, who wants to remain with the company, to sell his interest in the company at a value that may or may not be the fair market value. On the flip side, the owner who wants to stay may receive a large payout to move onto his next venture.

One way to combat this possible abuse is to designate a valuation method for the company. You could either (1) choose a valuation equation to be used, or (2) elect to use a third party appraisal (or an average of several appraisals). Another way to limit abuse is to only use the Texas shoot-out to be invoked for certain key matters. The advantage being that a buyout could not be forced unless a true deadlock situation had occurred.

In addition to a pre-determined method to establishing purchase price, the owners should consider pre-determined terms of payment. This includes how long an owner has to make a decision once presented with a deadlock clause and how the payment will be made. For example, will the purchase price be payable immediately or will the purchase price be paid over time through a promissory note? If a promissory note can be used, then you should also determine the basic terms of the promissory note, such as the term, interest rate, and consequences of default.  

The shotgun concept can be applied to a company with more than two owners, although this process is a bit more complicated. Each owner is offered the opportunity to purchase his pro rata share from a selling owner. If any owner chooses not to purchase his pro rata share, then the remaining owners have the opportunity to increase their percentage ownership interests by purchasing the remaining unpurchased interests. Several combinations of this method could be used as long as an owner is entirely bought out.

Aside from the Texas shoot-out, the owners could consider appointing a third or independent party to handle disputes, such as a trusted advisor, or the owners could divide the business in a split-off arrangement where each owner takes a piece of the business. The moral of the story is that you have options in the event of a deadlock. While you can’t have your cake and eat it too, you may be able to pick the piece.

The Series LLC: Is a Series LLC right for your business?

The series limited liability company ("LLC") is a relatively new way to organize business ownership. The series LLC has all of the benefits of a traditional LLC, such as flexibility and limited liability, with some added benefits that may appeal to your business such as the potential for a reduction in administrative costs and the further isolation of liabilities.

The series LLC is a group of mini LLCs all under one master LLC. This is a very similar concept to a parent corporation with many subsidiaries. Each mini LLC is independent from the other mini LLCs because each mini LLC has its own members, is only liable for its own debts and obligations, and can hold its own assets. The master LLC acts like an umbrella LLC or a holding company that controls all of the mini LLCs in the series. The series LLC started in Delaware and eventually became recognized as an entity type in Kansas and Missouri.

 A series LLC is ideal for someone who wants to form multiple LLCs within one large conglomerate without changing the function or business operations of each individual LLC. This is common for real estate investors or property management companies with multiple properties. A series LLC could also be used for a business with several different divisions or product lines. Each division could be its own mini LLC, thereby separating or limiting the liability to each division. Because each mini LLC is its own legal entity, each mini LLC must maintain separate corporate formalities such as a separate corporate book and its own financial accounts.

Not all states recognize the series LLC and formation procedures vary among the states that do. To form a series LLC in Kansas, the members must file Articles of Organization for the master LLC and then obtain a Series Limited Liability Company Certificate of Designation for each of the mini LLCs. The master LLC’s operating agreement must be carefully drafted to ensure that (i) a series LLC is specifically permitted and (ii) each mini LLC has limited liability (i.e. only liable for liaiblities within the mini LLC).

 To form a series LLC in Missouri, the members must file Articles of Organization for the master LLC and then file Form LLC 1A for each mini LLC. Similar to Kansas, the master LLC’s operating agreement must be carefully drafted to ensure that (i) a series LLC is specifically permitted; (ii) each mini LLC has limited liability (i.e. only liable for liaiblities within the mini LLC); (iii) each mini LLC must keep separate records, and (iv) the assets of each mini LLC must be accounted for separately.

Aside from isolating liabilities, a series LLC has other benefits such as potential reduced startup and administration costs. In Kansas, the filing fee for forming a stand-alone LLC is $160, whereas the filing fee for a master LLC is $250 and each mini LLC $100. Thus, filing for one master LLC and two mini LLCs in a series would be $450 compared to  filing three separate stand-alone LLCs which would cost $480. Additionally, Kansas requires ongoing administrative filing requirements for each LLC. However, a series LLC only needs to file one annual report for the master LLC and mini LLC, rather than separate reports for each LLC.

 Because Kansas only authorized the series LLC in July 2012 and Missouri only authorized the series LLC in August 2013, Missouri and Kansas have not clarified whether series LLC owners can file one consolidated tax return or whether each LLC must file a separate tax return.  Anyone contemplating forming a series LLC should consult their tax advisor about the tax implications applicable to their business. For more information on the series LLC or to see if it is right for your business contact Sheila Seck at 913-815-8485 or sseck@seckassociates.com.

What Rights Do You Have in Your Business Name?

There are many different types of protections available for a business owner’s name. The most basic protections come from having a legal name, whereas a trademark can carry with it national (and sometimes international) protections.  Below is a simple breakdown of some different types of business names and the protections they provide.

·   Legal Names. A business’s legal name is the name filed with the applicable state when the company is formed. This name is also on file with any other state where the company registers to do business. Once you register a name with a state, no other business may register to use that name in the same state, although variations of the same name are allowed; however, another business could register with the same name in a different state. The legal name does not provide much protection except that no other company may have the same name in the states where a company registers to do business.

·   Trade Names. A trade name is the name that a company uses in conducting business with customers. A trade name may be the same or different than the legal name. A trade name may be a fictitious name often referred to as a “Doing Business As” (DBA). For example, you may register your legal name as Jewelry Makers LLC, but you may operate that business as Jazzy Jewels or something completely different, like Julie’s Sparkles. Here, your trade name would be Jazzy Jewels or Julie’s Sparkles. Many businesses choose to never acquire a fictitious name, in which case the company would operate under the legal name and not register for a trade name. If you want to use a trade name in Missouri different than your legal name, you must register it. Kansas has no such requirement. It is important to know that a registered trade name will not necessarily allow you exclusive rights to a name. In Missouri, if your trade name, but not your legal name, is Jazzy Jewels, another company could register their legal name as Jazzy Jewels LLC.

·   Trademarks.  A trademark is protection for a word, name, symbol, sound or color that distinguishes your goods or services as unique from other goods or services. Think of a trademark as your logo or slogan. Trademarks must meet specifications that distinguish your logo or slogan as special or different from others in the same market.  State common law and state statutes provide trademark protection; however, federal law provides the most extensive source of trademark protection. Trademarks must be registered with the state or the U.S. Patent and Trademark Office. There are also some international trademark associations such as the Madrid System.

Each business owner’s needs are different and require an in depth analysis of the business operations, the current and future business plan and the desires of the owner(s) in order to determine the appropriate path for a business. 

Gaining a Competitive Advantage: Resources available for women and minority owners

Most business owners know the SBA can provide many different benefits for small business owners. What you may not know is that the SBA also provides certifications for particular types of business owners, including minorities, veterans and women. Obtaining these certifications could give a business a competitive edge in seeking new business opportunities and establishing credibility in the market. Government agencies, contractors and many other businesses have both governmental regulations and internal policies that mandate a certain percentage of contracts be awarded to minority-owned, veteran-owned and women-owned businesses. An SBA certified business is in a good position to receive contracts from businesses or government entities.

What are the basic requirements for certification?

Women business owners may get certified as a Women Business Enterprise (WBE), a Women-Owned Small Business (WOSB), and an Economically Disadvantaged Women-Owned Small Business (EDWOSB). Each designation has its own requirements and provides its own benefits. The core requirements of all designations are that a woman must:

1. Own and control at least 51% of the business,
2. Be active in daily management, and
3. Serve as the highest ranking member of the company.

Qualifications for the WOSB and EDWOSB also require that the company be a small business. What qualifies as a small business is determined by the SBA based on where the business falls under the North American Industry Classification System (NAICS). Additionally, the EDWOSB certification requires that the woman owner is economically disadvantaged. A woman is presumed economically disadvantaged if:

1. Her personal net worth is less than $750,000,
2. Her adjusted gross yearly income averaged over the three years preceding the certification does not exceed $350,000, and
3. The fair market value of her assets (including her home and business) does not exceed $6 million.

Additionally, there is a certification available for any Service Disabled Veteran-Owned Small Business Concern (SDVOSBC). Eligibility requires the service disabled veteran to:

1. Have a service-connected disability,
2. Be the owner and operator of a small business, and
3. Hold the highest officer position in the company.

The SBA also runs the 8(a) Business Development Program which helps small disadvantaged businesses. The 8(a) program is a nine year program split into two phases. The first phase helps businesses through a four year developmental stage and the second phase is a five year transition stage. Participants in the 8(a) program receive specialized business training, counseling, executive development, the ability to receive sole-source contracts, and the opportunity to participate in an exclusive mentor-protégé program.

How does a business owner obtain certification? 

A business may be certified as a WBE, WOSB or EDWOSB in two ways. A business owner can either self-certify through the System for Award Management (SAM), a government-maintained database, or use a third party certifier. If using a third party certifier, a business owner can choose between four SBA-approved third party certifiers for WBE and WOSB and three third party certifiers for the EDWOSB designation. The certification process includes an application and detailed documentation proving ownership and control. Required documentation may include financial statements, tax returns, bank account and loan information, operational documents, resumes for all owners and key employees, licenses and permits, lease agreements, and other requested information.

Essentially, the application and documentation are the same whether a business owner self-certifies or uses a third party certifier. The main difference in the two methods is what documentation can be seen by others. If an owner self-certifies, the owner must upload all of the required documents to an online repository. Anyone considering awarding business to the potential WBE, WOSB or EDWOSB has the ability to review the documentation to ensure that the self-certification is accurate. Conversely, if an owner uses a third party certifier, the owner provides all necessary documents to the certification agency. The owner will receive a certification document upon approval. Anyone considering awarding business to the potential WBE, WOSB or EDWOSB, will only access the approved certification document from the repository.

The SBA maintains control over ensuring the accuracy of certifications and continued compliance with the requirements. The SBA may investigate the accuracy of any certification or representation of self-certification. Additionally, any interested party (another business bidding for the same contract) or a contracting party may submit a protest against any business that they believe does not meet the certification requirements. The SBA is in charge of reviewing each protest and issuing a final determination. 

How long does the certification last?  

Some states provide their own state certifications which vary in length depending on the state. The federal certification for a WBE, WOSB, and EDWOSB lasts for one year. The re-certification process after the initial application is approved is much simpler if a third party certifier was used.

Interested? 

Certification as a WBE, WOSB or EDWOSB can provide access to local, state and federal government agencies looking for certified companies to meet their contracting needs. For more information visit www.SBA.gov or contact Sheila Seck, at 913-815-8485 or by email at sseck@seckassociates.com, for help in navigating and completing the application process.