Q: Our agency has several dozen home-based independent contractors (ICs) in various locations throughout the U.S. Because of the ongoing risk that our ICs could get reclassified as employees by state or federal government agencies, we are considering simply converting them to employees as a preventive measure. Are many agencies doing this? It is by no means certain that the ICs will agree to this conversion because they generally like their independence, but assuming that they agree to become employees, what are the costs, burdens and risks involved?
A: It is rare for an agency to convert all of its ICs to employees in the absence of government threat or compulsion. I have heard of it only in cases where the agency had a special need to control outside salespeople's day-to-day activities.
One of the reasons for its rarity is surely that ICs prefer their independence. However, there is no inherent reason why a home-based agent cannot act as independently as an employee as he or she can as an IC.
Another reason is cost. With employees, the employer must pay the employer's portion of federal or state withholding taxes. For 2019, employers will have to withhold 6.2% of the first $132,900 in pay for Social Security plus 1.45% of all pay for Medicare. Most states have withholding taxes on top of the federal withholdings.
However, when making the conversion to employee status, the parties can agree to reduce employee compensation by the amount of the withholding taxes, so that the employee effectively nets the same amount he or she would as an independent contractor, who is normally responsible for both employer and employee Social Security and Medicare payments.
I suspect that other factors inhibit these conversions, as well. First, if as with your agency, there are workers in many states, you have to deal with the substantial red tape involved in registering your business as an employer for withholding taxes, workers' compensation taxes and unemployment in each state. Although payroll services can handle most of this red tape for you, the cost in time and money is still substantial.
Your employees also become entitled to the benefits of wage and hour laws. That means that you will have to make sure they earn at least the federal or state minimum wage (whichever is higher) for all hours worked and time and a half for overtime, unless they qualify for an exemption. You will need a reliable method of tracking hours worked, such as a GDS login and logout.
Further, the state in which the employee lives may have other labor laws that you must obey, such as meal-break requirements, deadlines for paying employees and sick-day requirements. Employees are also entitled to the benefits of civil rights laws, such as prohibitions on employment discrimination and sexual harassment. With few exceptions, these laws do not apply to independent contractors.
If you add many new employees, you may have new obligations under health insurance laws. For example, under the Affordable Care Act, once you have more than 50 full-time and full-time-equivalent employees, you will need to have an employer-sponsored health insurance plan, which can be quite costly.
One more thing: It will be much harder, or even impossible, to impose post-employment restrictive covenants on employees than on ICs. For example, in California, it is against the law to prohibit ex-employees from competing with you, but no such law applies to ex-ICs.
If this sounds like a list of good reasons not to convert your ICs to employees, now you know why so few agencies attempt it.