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Contractor Beware: An Employee Classification Pitfall

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Did you know that people hired by contractors are presumed to be employees by state law? – even if a contract calls them independent contractors!  

Beginning on January 14, 2014, individuals can be held liable for violations of the Employee Classification Act. If you are a contractor who employs independent contractors, you need to become familiar with the rules that apply to the people that you hire.

You may think you have hired independent contractors,

but the State of Illinois may disagree with you!

Employing an independent contractor is actually an oxymoron. Independent contractors are not employees; though contractors often call people they hire independent contractors, but treat them like employees. That is exactly what this Act is designed to prevent, and the penalties for confusing the two roles can be very stiff.

Many contractors do not want the hassle of hiring employees because of the pay roll burdens and expenses. Employees mean state and federal income tax withholding, workers compensation insurance, unemployment insurance, unions and other burdens and expenses.

The State Employee Classification Act takes away some of that discretion and requires that contractors treat people retained to perform work for contractors as employees unless specific criteria are met. Those criteria are:

  • The contractor cannot control or direct the performance of the individual;
  • The work the individual is retained to perform is outside the scope of work the contractor usually performs;
  • The individual retained has an independent trade, occupation, profession or business;
  • The individual is a legitimate sole proprietor or partnership (in other words, the individual must have have his/her own business)

The Act also defines a legitimate sole proprietor or partnership. To be considered a legitimate sole proprietorship or partnership, the sole proprietorship or partnership (the “business”)

  • Must be free from the direction or control of the contractor – the contractor cannot dictate the means or manner (how the service is performed) and can only dictate the result;
  • The business must survive and continue after the relationship is terminated;
  • The business must have its own investment of capital beyond ordinary tools, equipment and a vehicle;
  • The business must own its own capital, reap its own profits and bear its own losses;
  • The business must make its services available to the general public on a continuous, ongoing basis;
  • The business must pay taxes like a business;
  • The business must have a business name (hiring Joe Worker means that you are hiring Joe Worker as an employee);
  • Any license required for the services must be licensed in the business name (if Joe Worker holds a license only in his own name, you are hiring Joe Worker as an employee);
  • The business must have its own tools and equipment necessary to perform the work;
  • If the business has its own employees, they must be hired without your approval and without reimbursement from you, and the business must report its employees’ income to the IRS;
  • The business does not think it is an employee or tell other people it is an employee;
  • The business has a right to work for others on whatever terms and whenever it chooses.

In other words, if you are not hiring a business, you are hiring a person, and the person must be treated like an employee. State law does not allow a contractor to have it both ways.

Issues with employee classification often arise when a person is terminated and that person files for unemployment compensation. If that person has not been paid like an employee, the Department of Employment Security will flag the employer and launch an invstigation that will involve the IDES, the Department of Labor and the Department of Revenue. No one wants to be under the State microscope because the State will be motivated to find violations of any law they can find to justify the investigation.

The failure to classify employees properly is a violation of the Act. Any “interested party” can file a complaint with the Department of Labor. The DOL has the authority to investigate, subpoena persons to testify, issue cease and desist orders, collect compensation or benefits that should have been paid to employees and impose a penalty up to $1000 for each violation found by their investigation. The penalty is doubled for repeat violations.

If a contractor gets a notice of violation from the DOL, the contractor must respond within 28 days. A determination of violation by the DOL is reviewed by the Attorney General’s office to determine if the violation was criminal.

Contractors who hire independent contractors, must report annually to the DOL all payments made to those individuals. Failure to report is a violation of the Act.

If a contractor hires independent contractors, the contractor must post a notice that is provided by the State Department of Labor “in a conspicuous place on the job site”.

If you are a contractor, own a contracting business or are involved in the management of a contracting business that hires independent contractors, you should become familiar with the Employee Classification Act and be careful to comply with it.

There are many other traps for the unwary contracting business, large or small. To make matters more confusing, classification of employees and independent contractors by the State Department of Revenue and the Federal Internal Revenue Service involve a different set of rules. Many state laws in recent years have added to the burdens that especially small contracting businesses face, and they have kept local law firms who represent them very busy.

For more information on other topics affecting businesses, business people and families, check the Drendel & Jansons Law Group blog and for resources, check the Drendel & Jansons Resource Page.

If you want help or advice regarding a specific matter, please contact us.

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