When you’re a small-business owner hiring contractors or freelancers, there are a lot of mistakes you might make, such as…
- Hiring a friend who flakes out on you halfway through a project.
- Booking someone whose technical skills are lacking.
- Taking on someone more interested in your office’s free snacks than in working.
But the biggest mistake many tech business owners make when hiring a freelancer or contractor is misclassifying workers.
A Contractor Is a Contractor – Except When They’re Really An Employee
Accidentally classifying an employee as a contractor is a topic we've touched on before in “Employee vs. Contractor vs. Freelancer: Which Is Right for Your Tech Business?” and “Hiring Freelancers / Contractors? Do These 5 Things First.” As you might've guessed, this is a very common issue for small IT business owners.
Even if you’ve hired contractors for years without any problems, it doesn’t mean you won’t get dinged for a misclassification in the future. What usually brings the issue to light is when a current or former contractor is injured and files a claim for Workers’ Compensation Insurance. Even if the worker says they’re a contractor, the organizations governing those issues in your state may disagree, and that’s where the problems start.
“Technically, independent contractors and freelancers are excluded from Workers’ Compensation coverage, but depending on various factors concerning how work is performed or supervised, workers who are hired as freelancers or contractors may ultimately be defined as employees,” says
Mike Jacobson (@HRTerminator),
legal editor at
(@XpertHRusa). “If any of them are injured or become ill while working, they could be eligible for Workers’ Compensation coverage, the absence of which could expose an employer to a major lawsuit.”
How One IT Startup Found Out Its Contactors Were Really Employees
The situation: Like many startups, cyber security consulting firm Kalki Consulting started out small, making do with just a handful of employees and rounding out its ranks with contractors as needed.
“During the first period of our business, we used contractors almost exclusively,” says
Vikas Bhatia (@vikasbhatiauk),
founder and CEO of
(@kalkiConsulting). “We were using them for everything from the delivery of services to administrative functions, like finance and HR.”
The red flag: This business model worked fine for a while, but all heck broke loose when the company transitioned away from a contractor who then filed for unemployment insurance benefits.
“They sent her a questionnaire that asked what type of work did you do, etc., – all the questions that delineate contractor versus permanent employee,” says Bhatia. “One of the questions they use for determining if someone should be considered an employee is, ‘Does the company provide you with the tools to do the job?’ So if you provide them with a laptop, phone, desk, or even an email address, that is considered a tool.”
Bhatia says the contractor had worked from home, using her own laptop, but because Kalki Consulting provided her access to their CRM and email system, that pushed her into the category of employee as far as the unemployment insurance office was concerned. At that point, he was informed his company was being audited.
“We needed to go back to day one and show all of our financial records, contracts with contractors,” says Bhatia. “They literally went through every single person we worked with. It was crazy, very time consuming, and very stressful.”
The outcome: Bhatia said one thing he learned during the audit was that it falls on business owners to prove that someone is an independent contractor. Just because a contractor provides invoices and is issued a 1099 doesn't make them a contractor.
“The net result of the audit was that in 2013, we had to pay unemployment insurance for a lot of individuals that they had been classified as employees even though we had them listed as independent contractors,” says Bhatia. “It was quite an expensive affair.”
The Takeaway: Learn How to Manage Your Risk
Bhatia says his company was already in the process of transitioning away from working with contractors at the time of its run-in with the unemployment insurance office. Following the audit, the company…
- Hired a professional employment organization to manage HR needs.
- Took steps to ensure any future contractors are truly contractors.
“We’ve got a checklist the auditors gave us that we go through if we need someone, no matter if it’s for three months or just two hours,” says Bhatia. “We also decided that any contractors we work with need to have their own company, meaning they need to be incorporated and have their own contractor liability insurance.”
Bhatia says the experience was a real wake-up call for him and his colleagues. He added that while he believes all business endeavors involve risk to some degree, what he learned from this experience was the importance of knowing how to best mitigate those risks.
“I think that most young firms are so focused on the growth, their reputation, and revenue that compliance or mandates are often ignored until it’s too late,” says Bhatia. “It may be worth it for smaller organizations, particularly startups, to make sure that they have some sort of relationship with an advisor that can provide a view of the risk involved.”
One way to manage your business’s risk is with liability insurance policies, such as General Liability Insurance, Errors & Omissions Insurance, and Workers’ Compensation Insurance. It’s also a good idea to review your policies as your business grows to make sure your policies keep pace with your business. Read “End-of-Year Insurance Review: 6 Things to Check on Your Policies” for more tips.
About the Contributors
Vikas Bhatia is the founder and CEO of Kalki Consulting. Headquartered in Manhattan with offices in California and London, Kalki provides SecurITy ™ to small- and medium-sized businesses in a range of different industry sectors, including financial services, healthcare, education, and manufacturing. Vikas has more than 18 years of enterprise information technology experience with more than 16 years dedicated to information security operations, auditing, compliance, and consulting engagements. He was awarded permanent residence status in 2012 by US Citizenship and Immigration Services, which deemed him a “person with exceptional ability in the national interest” in the area of information security.
Michael C. Jacobson is the legal editor for the Organizational Exit and Investigations and Litigation sections of XpertHR. Prior to joining XpertHR, Michael worked as an attorney in Manhattan for six years where he defended employers and healthcare providers against wrongful termination, discrimination, medical malpractice, and general liability claims. Michael obtained his JD from the Benjamin N. Cardozo School of Law, where he was the notes and comments editor for the Cardozo Public Law, Policy and Ethics Journal.