Employees vs. Independent Contractors and why it matters.

When starting a business and bringing staff on board, you must decide whether those individuals providing the services are employees or independent contractors. This post provides important information about how to classify your workforce and avoid costly penalties.

In my experience, many start-ups bring on initial staff as Independent Contractors — this way, they don’t have to withhold payroll taxes or provide benefits such as sick days or workers compensation.  However, according to the Department of Labor, up to “30% of companies misclassify their workers”  (See Statement by Deputy Secretary of Labor, Seth Harris, June 17, 2010; this results in billions of dollars of losses for the IRS so naturally they are now cracking down.

As of January 2013 when payroll taxes increased from 4.2% to 6.2%, a new level of scrutiny will applied to companies to make sure they are properly classifying their workers.  If you are later found to have misclassified an Employee as an Independent Contractor, the IRS can retroactively assess back payroll taxes and slap on penalties.

To be clear, Independent Contractors are generally those people you hire to complete a specific task or project; they work intermittently or on a temporary basis. in Examples include: accountants, lawyers marketing consultants, trainers or outsourced developers. These people tend to work primarily from their own homes/office and at their own hours and serve clients other than you. In other words, unlike an Employee, you do not control their “when, where and how” work is to be performed. For this reason, a company does not need to withhold taxes or provide benefits to Independent Contractors.  At the end of the year, your company issues them an IRS Form 1099 reporting all the monies that were paid to each individual.  It is the individuals’ responsibility to file returns and pay their own taxes for the amounts received.

Once you have set up an LLC or Corporation and start to bring on a workforce, follow the link below to review the IRS’s 20 Factor Test to find out whether someone should be classified as an Employee or Independent Contractor. If you think you have misclassified a worker — not to worry — as of 2011, the IRS began offering a Voluntary Classification Settlement Program to change the status of workers without penalty.  Click here for more information.

This is one area you don’t want to procrastinate — a falling out with an outside contractor that leads to litigation can open up a can of legal worms. States are working more closely than ever with the IRS to ensure that they are not missing out on the additional 2% of flesh from each worker’s paycheck. For more information, check out Forbes article, New Crackdown on Using Independent Contractors (Nov. 12, 2012).

Lastly to note, if you have determined that someone is legitimately an Independent Contractor, be sure to sign an agreement that obligates them keep your information confidential, requires that they transfer rights to intellectual property and itemizes the work product they have committed to deliver (and you have agreed to pay for), to avoid any disputes down the line.

Any doubts or questions as to whether you are properly classifying your workforce? Free to email me or post your questions below.

Is there a topic you would like to see covered on BrillsonLaw? Would you like to be a guest blogger?  Email


The Compassionate Leader. 

As an attorney and executive adviser, I have been regularly called upon by management (or their boards) to manage  crisis.  Whether it is an employee or director matter, a falling out between partners, a threatened litigation, or breach of confidentiality; all companies face crisis from time to time. While external issues are not always in the control of management, internal issues typically are. Whether internal/external, how these threats are handled are indicative of the type of leadership skills management possesses.

In a recent workshop at the Thiel Foundation’s 20-Under-20 Retreat, I asked 30 new entrepreneurs and mentors what they thought was one of the most important qualities in a Leader.  The responses I received ranged from:  a hard worker to a multi-tasker to having a vision.  While these are all important traits, in my opinion, one of the most important ones is compassion and here’s why:

  • Employees know whether or not you really care about them – if you listen to their ideas, communicate openly, understand their key strengths, and compensate them fairly.
  • Clients will  know if you truly care about them — if you are responsive to their needs, provide proactive customer service and offer solutions that help them work better/smarter/faster.

Sure, management is under a great deal of pressure to meet sales objectives and satisfy their Board of Directors.  At the same time, startups are generally cash strapped and may try to do things on a shoe-string but what are some of the real underlying problems that generally lead to crisis mode?

1. Shutting out those who know the problem best.

Employees are generally aware of the issues at hand and some may have good suggestions on how to turn things around; after all, they are the ones in the trenches who have a vested interest – a continuing paycheck and a potential payout on their stock options. Keeping them in the dark creates an environment of distrust and insecurity.

In one case, the CEO held a weekly conference call with the team. The majority of the time when someone voiced an issue the response would typically be: “This isn’t relevant to the rest of the group; let’s take this out of band.” Needless to say, that offline conversation rarely happened.  After awhile, the weekly conference calls were nothing more than a cheerleading session where most people were on mute (e.g., doing other things) while the CEO congratulated himself and the team or staying in business for yet another week.

2. Promising what you can’t deliver.

Employees and consultants share the same ongoing objective – getting paid for their work and having access to necessary resources. Unfortunately, management doesn’t always get the memo.

In one startup, consultants were rarely paid on time and employees’ expenses were not readily reimbursed.  They’d hear the “check is the mail” and then two weeks later, nothing. “ One employee who reportedly emailed the CEO on a daily basis to let him know there was still nothing in his mailbox finally received his check with an added bonus: a termination notice inside.

In another instance, the product specs were oversold; customer deadlines were not being met and the CEO’s phone went straight to voice mail. Employees had no idea what to communicate to their accounts and so eventually, their business began migrating elsewhere.

3. Gossiping about others.

To me this is probably the worse offense I’ve witnessed in a company — the CEO who gossips about his employees, his board members and even his customers.   Sure it’s hard to be the CEO when you’re at the top of the food chain and no one to gripe to but hey, haven’t you heard…. it’s lonely at the top.

A recent Randstad survey of more than 1,500 U.S. employees found that three out of five workers listed gossip as their top workplace pet peeve. If the CEO is gossiping to me about someone else…what is he saying about me to others?  In that environment of distrust, everyone’s watching his back and not the bottom line.

Compassionate leaders can avoid or manage crisis best when they listen to the concerns/feedback from the team, communicate expectations clearly and honestly and doesn’t disrespect others by gossiping.  A leader that chooses to cultivate compassion will have a significant advantage over those that do not. Business owners may consider this “Dalai Lama approach” to be too touchy-feely, but in truth, cultivating positive relationships is at the core of any successful business or relationship.

What are you thoughts on compassionate leadership? I’d love to hear from you!



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