Startups/Small Companies are often tempted to find ways to either lower workers’ compensation costs or avoid the purchase of workers’ compensation insurance entirely. Although it’s always a good idea to be sure you are getting the most for your money, beware of apparently easy paths that ultimately might lead to big trouble.
One of these shortsighted moves is an startup’s decision to declare certain (or all) employees are independent contractors and thus exempt from the employer’s workers’ compensation requirements. They have discovered that by hiring “independent contractors” rather than “employees”, they can save on workers’ compensation insurance as well as state and federal taxes.
However, you risk considerably tax fines, other penalties, and a serious gap in insurance coverage if your “independent contractors” are later determined to actually fit an “employee” definition.
In the old days, it use to be easy to distinguish an employee from an independent contractor; the employee had withholdings taken out of their check, the independent contractor didn’t.
Then the IRS realized they were losing $30 billion dollars a year in tax revenue where employees were misclassified as independent contractors. Now every IRS audit will look into whether workers are being classified correctly. In addition, the Colorado Department of Labor has their own fines and penalties.
But it’s not just the IRS and Colorado DOL penalties and back taxes you have to worry about on this issue. You risk serious financial loss if an injured independent contractor is determined to actually be an employee and you failed to carry workers’ compensation insurance. While most standard general liability policies will protect you from lawsuits for injuries to independent contractors, none will provide you protection for injuries to employees. Only a workers’ compensation policy will do that.
One of the key advantages of workers’ compensation laws for an employer is the limitation on the right of the injured employee to sue the employer. In effect, the employer makes a trade with the employee – the employee automatically receives benefits for being injured on the job, even if the injury was partially or entirely the employee’s fault, and the employee gives up the right to sue to recover damages for those injuries in court, even if the employer was at fault. In today’s litigious society any protection against the open-ended damages that a court might award is a valuable benefit.
Yet, if the injured person is an independent contractor, no workers’ compensation benefits are received, which means that there’s no limitation on their ability to sue the business for whatever damages the court will award. In effect, when you elect to use an independent contractor instead of an employee, you might be trading immediate and limited savings on your workers’ compensation premium for exposure to legal damages which could easily exceed the normal general liability policy limit of $1,000,000.
The key issue in determining whether an individual is a contractor or an employee is the degree of control the company exercises over how the person does a job.
The following are some of the criteria used to determine employee vs independent contractor. Remember, if even one of the independent contractor criteria is not met, the worker could be considered an employee.
| An Employee | An Independent Contractor |
| Has a continuing relationship with an employer. | Does the same work for others that is done for you. |
| Normally is furnished significant tools, materials, etc. by the employer. |
Has own tools and equipment and can hire, supervise and pay assistants. |
| Can quit at any time without incurring liability. | Can make a profit or suffer a loss. |
| Must comply with instructions about when, where and how to work. |
Sets own hours and work schedule. |
The IRS publishes complete guidelines for determining a workers’ status. Talk to your tax adviser or legal counsel for guidance.
There are many advantages to the use of independent contractors. But it’s critical to weigh the possible effects on your insurance coverage
when making such business decisions. Give us a call and we’ll be glad to review your situation with you.
Our suggestions to give you some peace of mind:
1. Buy a workers’ compensation policy – even if you think you don’t have any employees.
Whether you have employees or not, buy a workers’ compensation policy. Then, along with your general liability policy, you will have protection
from either employee or independent contractor injuries. Don’t wait until an injury to find out who you thought was an independent
contractor has been determined to be an employee and you didn’t buy workers’ compensation insurance.
Many insurance companies will sell you a workers’ compensation policy, even with no employees, and only charge you their minimum policy
premium.
2. Make certain the independent contractors you do hire have their own workers’ compensation insurance.
Have them furnish you with evidence of coverage with a Certificate of Insurance. And mark their policy expiration down on your calendar to remind yourself to request a renewal Certificate before their policy expires. (While you’re at it, make sure their general liability coverage is also listed on the Certificate and that you’re named as an Additional Insured)
Your workers’ compensation insurance company will want to see copies of your independent contractor’s workers’ compensation Certificates.
Without the Certificates, your carrier may consider the independent contractors your employee and charge you an additional workers’
compensation premium.
Rule of Thumb: ALL your workers, whether employees or independent contractors, should be covered by workers’
compensation insurance. If your independent contractors don’t have it, you may be responsible for their injuries. Numerous court cases have ruled the hiring party is responsible for injuries to independent contractor’s employees when the independent contractor did not have their own workers’ compensation insurance.