By Brian Clemow
Shipman & Goodwin

This article is intended to provide general information only. It is not intended as legal advice or as a solution to an individual problem. You are encouraged to consult with appropriate legal counsel prior to relying on this document in whole or in part.

In the past few years, many companies have expanded their use of nontraditional workers, including part-time and temporary employees, agency temps, and independent contractors.

Not only do these alternatives offer more flexible staffing than traditional full-time employees, but they also can free management from some of the burdens usually associated with being an employer.

For example, independent contractors usually require no fringe benefits, no payroll taxes, and often no office space, tools or equipment. They can be hired and terminated at will, and they require little or no day-to-day personnel administration.

However, many companies have found that, like some other things that seem too good to be true, using independent contractors can cause major problems.

For one thing, establishing that someone who works for you is truly an independent contractor is not easy. The IRS has developed a 20-factor test for independent contractor status, and if you fail it, the penalties can be substantial.

The dangers of misclassification, as Microsoft recently discovered*, can include unanticipated coverage under company pension and other employee-benefit plans. But even if a worker is correctly categorized as an independent contractor, that does not protect management from risks, including some that do not apply in the normal employee setting.

One example is workers’ compensation. When an employee is injured on the job, his or her only recourse is through the workers’ compensation system.

An independent contractor, however, can bring a lawsuit alleging negligence, defective machinery or equipment, or other grounds for liability. While the company can achieve some protection by negotiating appropriate terms into the agreement with the contractor, this problem does not even arise in an employer-employee relationship.

Independent contractors also are not bound by the terms of a company’s employee handbook or personnel policies. This can be a problem in a variety of ways, but consider your non-compete and confidentiality policies as examples. Again, some of these issues can be addressed in the contract with the individual.

However, a non-compete agreement may threaten the person’s status as an independent contractor.

Even traditional assumptions about terminating an independent contractor relationship may be subject to question. Most companies assume they can end their relationship with an independent contractor whenever they want, unless they have agreed to continue it for a specific duration.

Some courts, however, recently have permitted contractors to sue for discriminatory termination of the contract relationship, despite the fact that statutes prohibiting employment discrimination do not apply to independent contractors.

Hiring an independent contractor is sometimes an excellent solution to a company’s employment needs. However, you should beware of adopting this approach as a panacea, because the problems can outweigh the promise. Your attorney, accountant or human resources consultant can help you make the right choice.

*An appeals court recently upheld a ruling that some of Microsoft’s “independent contractors” were employees entitled to participate in the company’s stock-option plan.

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