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Understanding Your Legal Liability as an Employer

Filed under Hiring Workers. Fact checked on May 25, 2012.

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Your liability as an employer under various employment laws, including wage and hour law, payroll taxes, and anti-discrimination laws depends on various factors including whether your workers are classified as employees and the number of employees you have working for you.

Once a business owner decides to hire workers, various federal and state laws come into play. If you decide to hire or lease employees or use independent contractors, it's extremely important that you understand the numerous federal and state laws that can affect your relationship.

Generally, whether or not a business is subject to specific employment laws depends on how many employees that business has and for how long. There's a large array of federal and state laws and, in some states, it only takes one employee to make you subject to certain employment laws. Therefore, to ascertain your legal liability as an employer you must first have an understanding of how an employee is defined for these purposes.

Warning

Business owners often think that the way to get around all of the employment laws is to have no employees and instead to employ leased workers, temporary workers, or independent contractors. In theory, this can work, but how well it works in reality depends on what the worker actually does and how you structure your contracts.

Who is Considered an Employee?

The common law definition of an employee is anyone who performs services if the one for whom services are performed can control what will be done and how it will be done. But definitions vary depending on whether the definition is applied for employment tax purposes by the Internal Revenue Service (IRS), or for determining whether your worker is an employee covered under the Fair Labor Standards Act (FLSA).

The common law rule defining an employee is applied even when you give the worker quite a bit of freedom of action. What matters is that if you have the legal right to control the method of the services — the how, when, and where — rather than just the results.

If not, the individual is classified as an independent contractor and is not your employee.

More specifically, an individual is an employee when he or she:

  • maintains a continuous relationship with an employer
  • is subject to the control of the employer, even if the employer chooses not to exercise the control
  • performs the work personally and receives required training, tools, supplies, etc.
  • works hours and locations that are assigned by the employer
  • qualifies for company benefit plans

Employees for purposes of the IRS. As far as the IRS is concerned, for employment tax purposes, a worker is an employee if the person for whom he works has the right to direct and control him in the way he works, both as to the final results and as to the details of when, where and how the work is to be done.

Example

A construction contractor was an employer of his workers since he supervised and controlled the workers, supplied major tools and equipment, sometimes dictated the manner in which a job was accomplished, and had the power to hire and fire. However, the employer need not actually exercise the control; it is sufficient that he has the right to do so. Where the employer does not possess that right, the individual involved is an independent contractor, not an employee.

The IRS has a 20-factor test that it uses to determine whether a worker is an independent contractor or is really an employee in disguise. The factors can carry different weights, depending on the factual situation. Generally speaking, if the worker would be considered an employee under at least 10 of the factors, you should treat him or her as an employee.

If in doubt, look at IRS Form SS-8, which is the form used by the IRS to determine individual status for purposes of income and employment taxes. You can use it to determine whether workers are employees.

Work Smart

The IRS takes a very strong stand on the incorrect classification of workers as independent contractors when they are really employees and frequently imposes back taxes, penalties, and interest when workers are improperly treated as independent.

For example, a woman owned a small pet grooming business. She hired independent contractors to do the grooming for her, and she had them sign contracts that stated that they were independent contractors.

At some later point, one of the groomers filed an unemployment claim, which prompted an IRS investigation. The IRS, applying its complex rules, determined that the groomers were employees rather than independent contractors.

As a result, she had to pay $13,000 to the government.

Therefore, if you are waiting for a determination from the IRS, a worker should be treated as an employee until the determination is made. All applicable taxes should be deducted and paid while the worker is in an employee position. You can petition for a refund if the worker turns out to be an independent contractor after all.

Employees under the FLSA. The FLSA is another important federal law governing your treatment of workers, and it has its own definition of who is an employee.

There are six factors for determining whether a worker is an employee under the FLSA and entitled to minimum wage and overtime-type protections, as opposed to an independent contractor:

  • the degree of the alleged employer's right to control the manner in which the work is performed
  • the alleged employee's opportunity for profit or loss depending upon managerial skill
  • the alleged employee's investment in equipment or materials required for the work
  • whether the service rendered requires special skills
  • the degree of permanence of the working relationship
  • whether the service rendered by the worker is an integral part of the alleged employer's business

No single factor is more important than the others, and when the issue comes up in courts, the judge must consider whether, as a matter of economic reality, a worker is dependent on the business to which a service is rendered for continued work. The greater the dependence, the more likely the worker will be found to be an employee.

Work Smart

Determining who is an employee can be complicated. In fact, in an annual poll, small business owners said repeatedly that the independent contractor rules are the government laws that they would most like to see clarified and improved.

In order to be absolutely sure that you're correctly classifying workers, you should meet both the IRS and FLSA definitions.

Temporary or Leased Employees

In almost all temporary or leasing situations, your business and the staffing agency are likely to be considered joint employers. That means that both of you will have some legal responsibility under federal and state employment laws that apply to your employees.

Also, just because you think you have structured your contracts to delegate responsibility to a staffing company, you may not have escaped all legal liability. For example, your business always retains liability for the safety of employees in the workplace under the Occupational Safety and Health Act.

However, generally, you can avoid payroll responsibilities when the individuals are supplied by a temporary or staffing agency, even if you have recruited them yourself. You may be able to exclude contingent staff from your employee benefit plans even if you are a joint employer, but you may have to include them in your "count" for coverage purposes and under certain laws, such as discrimination laws, if they have worked for you for more than one year.

Federal and State Employer Liability

When you hire employees--sometimes a single employee is enough--you bring a new level of complexity into your business and a new set of considerations related to employment laws. If you have employees, important federal employment laws you should be aware of include:

  • The Fair Labor Standards Act (FLSA): The federal wage and hour law covering such issues as minimum wage, overtime, child labor, and equal pay for equal work.
  • The Occupational Safety and Health Act (OSHA): The federal law that requires you to provide a safe work environment for your employees.
  • Payroll taxes: Employers have various federal tax obligations such as withholding and paying FICA and FUTA taxes.
  • The Employee Retirement Income Security Act (ERISA): A federal law that affects certain administrative aspects of employee benefit and retirement plans.
  • The Consolidated Omnibus Budget Reconciliation Act (COBRA): A federal law that requires employers of 20 or more to offer individuals who would otherwise lose benefit protection the option of continuing to have group health care plan coverage.
  • The Family and Medical Leave Act (FMLA): A federal law requiring employers with 50 or more employees to allow employees to take unpaid leave under certain circumstances.

Employers may also be subject to state law requirements in these areas as well.

Federal Anti-discrimination Laws

If you employ 15 or more employees, you should educate yourself regarding federal anti-discrimination laws. The Equal Employment Opportunity Commission (EEOC) is the agency that enforces federal anti-discrimination laws.

Title VII. Title VII of the Civil Rights Act of 1964, also known as Equal Employment Opportunity (EEO) mandates, prohibits employers with 15 or more employees from discriminating against applicants and employees in all aspects of employment — including recruiting, hiring, pay, promotion, training and termination — on the basis of race, color, national origin, religion or gender.

Employment decisions, therefore, must be made on the basis of business necessity, not on an employee's or applicant's membership in a protected class or group.

What is a protected group? In terms of employment laws, they are groups of people that are distinguished by special characteristics such as their race, color, ethnicity, national origin, religion, gender, age (over 40), disability or veteran status. These particular groups are protected under federal anti-discrimination law, which mandates that people in one of these protected groups cannot be discriminated against in any facet of employment, including hiring, promotion, training, discipline, pay, and termination.

Limited exceptions to Title VII discrimination laws known as bona fide occupational qualifications (BFOQs) exist, allowing a company to hire employees based on their religion, gender, or national origin where those factors are reasonably necessary to the normal operation of that particular business or enterprise.

Warning

BFOQs are rarely used because they are exceedingly difficult to justify. And where they are used the law does not permit religion-based, gender-based or national origin-based differences in pay to those holding the same job.

Areas most affected by Title VII include job advertisements, job qualifications, hiring decisions, job applications, interviews, discipline, and termination.

The ADA. The Americans with Disabilities Act, also known as the ADA, is actually a part of Title VII legislation and also applies only to employers with 15 or more employees. The ADA covers those who:

  • have a long-term physical or mental impairment that substantially limits one or more life activities
  • have a history of such impairment
  • are regarded as having such an impairment

As an employer, you must reasonably accommodate all individuals covered by the law, and you cannot do any of the following:

  • adopt different pay scales, benefits programs, or promotion opportunities for the protected group (assuming the differences harm the protected group)
  • enter into contracts with other companies that would have the effect of discriminating against your employees
  • discriminate against an employee in any term and condition of employment because a family member or friend was covered under the protection of the ADA
  • make employment decisions based on generalizations about a disability rather than the facts of a specific case

The ADA also affects such areas of employment as pre-employment medical exams, pre-employment inquiries about physical ability, job descriptions, job qualifications, absenteeism, and worker safety.

The ADA Amendments Act of 2008 (ADAAA) significantly broadens the scope of protection available under the ADA. The ADAAA broadens the definition of disability by modifying terms of the definition. The ADAAA expands the definition of major life activities, redefines who is regarded as having a disability, and modifies the regulatory definition of substantially limits.

GINA. The Genetic Information Nondiscrimination Act (GINA) prohibits employers from using individuals' genetic information when making hiring, firing, job placement or promotion decisions. GINA protects prospective employees and employees covered by Title VII of the Civil Rights Act of 1964.

The ADEA. The Age Discrimination in Employment Act, also known as the ADEA, applies to employers with 20 or more employees and is geared toward protecting individuals over the age of 40 against employment discrimination. Specifically, you cannot discriminate on the basis of age by hiring younger employees because they are younger, paying an older person less because the employee is older, or terminating an older employee before a younger employee because the older employee is older. The ADEA does say, however, that it is not unlawful for you to observe the terms of a bona fide seniority system.

Bona fide occupational qualifications are exceptions to the ADEA that allow you to require that an applicant be of a certain age.

Like other anti-discrimination laws, the ADEA affects several areas of employment including job advertisements, job qualifications, hiring decisions, job applications, interviews, discipline, and termination.

Do you have enough employees to be covered? The federal labor laws generally apply to employers above a certain size, defined in terms of the number of employees they have. But how do you count your employees if you have part-time workers, or if your payroll ebbs and flows with the seasons?

Generally, you must count all the employees who are on your payroll during a week. This means that you must count each of your part-timers, temporary workers, and leased workers as employees; however, don't count your independent contractors. Do this for each week in the year. If you meet the threshold number of employees under a given law for at least 20 weeks in a year, you are covered by that law for the entire year.

Posting requirements. If federal labor laws apply to you, you are required to comply with the applicable federal posting laws. The Department of Labor has downloadable posters available for small business employer regulatory compliance.

Employer's State Liability

One of the most important aspects of state law as it relates to employment is in the area of discrimination. While only employers who have 15 or more employees are subject to the most complex and comprehensive federal anti-discrimination laws, state laws sometimes require that an employer need only have one employee to become subject to anti-discrimination laws. Therefore, in some states, you could be exempt from the federal laws yet still be subject to the state civil rights laws.

State laws can also be broader in scope than the federal laws, with the result that protection is provided to groups in addition to those protected groups covered by federal law. State laws may protect other groups, such as individuals in different age groups, people who are smokers and individuals with a particular sexual orientation.

All of the states have enacted at least one law pertaining to employment discrimination. Keep in mind that the state law may not apply to you — it depends on the size of your business. But if it does, take steps to comply with it and consult a lawyer if necessary.

Warning

There are other areas of employment law that are often affected by state law, including: criminal record checking, polygraph testing, drug/alcohol testing, and the use of credit reports.

Consult our anti-discrimination employment law map for information on your state's law in this area.

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