Last month we discussed several ways to increase the profitability of your business by reducing operational costs. One of the cost cutting methods I suggested was to trim from your payroll any employee who did not either make or save money for your business. Based upon this advice, I received several inquiries asking about the use of independent contractors in place of employees. I even got a question regarding the utilization of unpaid interns as a labor source.
Why use independent contractors?
When legal, it is almost always advantageous for a business to classify its workers as independent contractors. Independent contractors are liable for 100% of the employment taxes owed on their income and they are not eligible to receive paid time off, healthcare benefits, or retirement benefits. In addition, the tortious actions of independent contractors are not the vicarious liability of the business for which they work.
Sign me up, I want all my employees to be independent contractors!
Establishing that a worker is an independent contractor is rarely simple, and not always possible. By default, every worker is an employee unless the business can show a principal/contractor relationship rather than an employer/employee relationship. Misclassifying an employee as an independent contractor also carries stiff penalties from the IRS and state taxing authorities, not to mention civil liability to the employee.
The IRS formerly used what was known as the “Twenty Factor” test to determine if a worker could be properly classified as an independent contractor. Under pressure from Congress and business and labor representatives, the IRS recently attempted to refine and simplify the test by condensing the twenty factors into three groups of eleven factors. As you might imagine, the test did not really become more simple, as each of the eleven factors must be examined and weighed, and there is no clear way for an average employer to decide which factors will weigh more heavily than others.
The independent contractor test.
The three groups into which the eleven factors used to determine if a worker may legally be classified as an independent contractor are (1) behavioral control, (2) financial control, and (3) relationship type. While a detailed analysis of each factor is beyond the scope of this discussion, the general idea of each group is as follows:
Behavioral Control
The idea behind behavior control is to examine how a worker completes his or her tasks. Independent contractors must not be subject to the direction and control of their principals. If the business has the right to direct how the worker completes tasks, the worker is likely an employee. Even if the business does not actually control the way work is done, having the unexercised right to direct and control is sufficient to establish behavioral control.
Another form of behavioral control is training. Independent contractors are not permitted to receive training from their principals. If a business gives training to a worker, it establishes that the business wants the worker to complete tasks in a specific manner, which is indicative of the behavioral control an employer exerts over an employee. If periodic or continuing training is provided by a business, this provides an even stronger indication of an employer/employee relationship.
Financial Control
Independent contractors frequently make significant investments in the tools and instrumentalities used to perform tasks. Employees, to the contrary, are usually supplied with everything needed to complete their work by the employer. There are no set investment figures by which to judge the significance of a worker’s investment, and this factor alone is never dispositive, but independent contractors generally have their own computers, their own software, and other similar tools. A worker using the tools of a business is likely to be considered an employee.
The opportunity for profit or loss is another consideration of financial control. Independent contractors are usually paid by a flat fee for a job, while employees are guaranteed a regular wage amount for an hour, week, or other period of time. Most expenses are reimbursed to employees, while independent contractors generally pay their own expenses. If costs increase, an independent contractor may be paid less than the cost of completing a task and lose money, shifting the loss to the employer. Showing an opportunity for profit or loss is a great way to support an assertion that a worker is an independent contractor.
Type of Relationship
A worker might contractually agree to independent contractor status in writing, but the IRS is not required to follow a contract stating that a worker is an independent contractor. Instead, the IRS will look at how the business and the worker interact.
Independent contractors usually work on a specific project or for a specific period of time, whereas an ongoing relationship is indicative of an employer/employee relationship.
The importance of the worker’s role in the business is also examined. If a worker provides services key to the success of a business, these services are more likely to be performed under the direction and control of the business, meaning the worker is an employee and not an independent contractor.
Interns. Did someone say free labor?
I gained a tremendous amount of legal experience as a law student toiling away in windowless rooms with five other unpaid interns just to have the honor of doing “real work” for an actual attorney. You probably have your own internship horror stories. Unfortunately, federal labor laws were drastically changed in January 2010, and the internships we all remember with such fondness are much more heavily regulated.
The current state of the Fair Labor Standards Act (FLSA) defines the term “employ” very broadly. Covered and non-exempt individuals who are “suffered or permitted” to work must be compensated under the law for the services they perform for an employer. However, there are some circumstances under which individuals who participate in “for-profit” private sector internships or training programs may do so without compensation.
The Supreme Court of the United States has held that a person whose work serves only his or her own interest need not be compensated. This may apply to interns who receive training for their own educational benefit if the training meets certain criteria. The determination of whether an internship or training program meets this exclusion depends upon all of the facts and circumstances of each such program, but the following six criteria must be applied when making this determination:
1.The internship, even though it includes actual operation of the facilities of the employer, is similar to training which would be given in an educational environment;
2.The internship experience is for the benefit of the intern;
3.The intern does not displace regular employees, but works under close supervision of existing staff;
4.The employer that provides the training derives no immediate advantage from the activities of the intern; and on occasion its operations may actually be impeded;
5.The intern is not necessarily entitled to a job at the conclusion of the internship; and
6.The employer and the intern understand that the intern is not entitled to wages for the time spent in the internship.
Unlike the test for determination of employee versus independent contractor status, which is a balancing test, ALL THE CRITERIA listed above must be met for an employment relationship to not exist under the FLSA’s minimum wage and overtime provisions. If even one of the six criteria are not met, the intern must be a paid employee.
Conclusion.
It is possible for a business to replace certain employees with independent contractors in order to reduce costs. However, a business needs to be very careful in selecting which positions might be good candidates for the use of independent contractors, and which positions should continue to be filled by employees.
Furthermore, while I always felt that trading my time for experience and a few extra lines on my resumé was a worthwhile exchange, it seems the federal government now disagrees.
Before classifying workers as independent contractors or bringing unpaid interns into your business, always speak with a trusted advisor who is knowledgeable in federal and state labor and employment laws.
Warm Regards,
Michael J. Leonard, Esq.
Attorney at Law
San Diego Corporate Law
www.sdcorporatelaw.com
leonard@sdcorporatelaw.com
858.483.9200 (phone)
858.605.6766 (fax)
Find me on Facebook: http://www.facebook.com/SanDiegoCorporateLaw
Showing posts with label reclassify employee. Show all posts
Showing posts with label reclassify employee. Show all posts
Sunday, March 6, 2011
Thursday, January 6, 2011
Increase Net Income by Reducing Costs
With this being the first week of a new year, it is a good time for business owners to think about how to increase net income in 2011. The knee-jerk answer is to increase gross income by increasing sales. This thinking is not flawed, as more sales should lead to higher net income. However, simply increasing sales is a one dimensional approach to increasing the bottom line. On a profit and loss statement, between the gross income and net income, there are a lot of costs. Decreasing these costs allows each sale to generate more net income, making it entirely possible to increase net income even on stagnant or shrinking sales. Cutting costs while increasing sales is even better for the bottom line.
The following are some of my suggestions for increasing net income by reducing costs.
START WITH GOOD FINANCIALS
Good financials not only show how much money is coming in and out of a business, but in great detail show WHERE the money is coming from and WHERE the money is going. Without good financials, it will be impossible to know which cost cutting efforts will significantly cut into sales and which will have little or no effect on sales.
Start looking at the financials. If good financials are not available, hire a bookkeeper or accountant to set up a proper accounting system and generate them. Financials will only cost a couple hundred dollars per month for most businesses, and this investment could be worth thousands of dollars per month if the information is used properly.
If you do not currently use an accountant or bookkeeper, call me or send me an email and I will gladly suggest a few professionals I trust.
ONLY KEEP THE RIGHT EMPLOYEES
Employees are the usually the largest single business expense. While most businesses cannot survive without employees, cutting costs while increasing sales is about having the right employees in the right positions, and not necessarily just fewer employees.
Every person drawing a check from a business needs to be doing one of two things: (1) Making the business money; or (2) Saving the business money. Identify how each employee is either making the business money or saving the business money. It is not always obvious.
For example, do not fire a receptionist doing tasks for $10 per hour when other staff will have to do this work at $25 per hour. The receptionist is saving the business money.
A contrary example is that of a salesperson who does not up-sell or cross-sell. This salesperson is not making the business money because anyone can answer simply answer a phone and take orders from customers. Replacing this salesperson with another, more motivated salesperson who actively seeks out new sales and works to increase the amount of goods or services sold in each sales transaction is an example of a salesperson who makes money for a business.
ADVERTISE WITH A NARROW FOCUS
Advertising is another typically large business expense. Advertising smarter by narrowing the focus of distribution will reduce costs while giving a greater return on investment for each advertising dollars.
Figure out where customers are located and direct advertising there. Is a client going to drive from their home or office to a frozen yogurt shop miles and miles away, or will they just go to the closest place to get what they want?
Also think about the media in which advertisements are placed. Do not advertise hearing aids on the internet or snow boards in a newspaper. Understand how to best reach customers, and quit wasting money advertising in the wrong media.
If it is unclear where clients are coming from or how they learned of the business, just ask them at the first contact or point of sale.
FASTER INVENTORY TURNOVER
Streamlining procurement is another way to save big money and free up capital. Many businesses get sucked into buying too much product from distributors offering price breaks on quantity. Yes, a 10% price break might be extended for restocking in bulk, but if the inventory does not turn at least every 30 to 90 days (this is industry dependent), too much capital is tied up in inventory and increases costs in several ways.
Costs associated with slow inventory turnover include spoilage, obsolescence, cost to insure inventory, and cost to warehouse inventory. Spoilage and obsolescence will cause inventory to be discarded or sold at deep discount, while high insurance premiums and high rental rates also create unnecessary drains on gross income. If too much of a perishable or trendy item is stocked, when the perishable spoils or when yesterday’s trend is no longer selling, that inventory must be sold at a deep discount (if you are lucky) or thrown in the dumpster; a costly waste of your money.
Consider using necessities or options contracts to secure the ability to purchase at a discount and never run out of inventory while at the same time not purchasing more inventory than necessary at any given time.
PAY LESS TAXES
Every business needs a solid strategy to deal with taxes. While paying taxes is unavoidable, there are options available to businesses to reduce tax liability.
Classification of a worker as an independent contractor rather than an employee passes the duty to pay employment taxes and workers compensation insurance to the independent contractor. While this savings is significant for the business, not every worker is eligible for classification as an independent contractor and improper classification of a worker as an independent contractor can result in expensive fines and other penalties from the Internal Revenue Service, so get some professional advice before reclassifying any employees.
The type of business entity used to conduct business can also have a significant impact on tax liability. For example, sole proprietorships are typically more heavily taxed than corporations organized under Subchapter “S” of the Internal Revenue Code. These “S-Corps” allow the business owners to split income between salary subjected to employment taxes and net income not subjected to employment taxes; a difference of 15.3% in tax liability.
A business attorney can help determine which business entity will be best suited for reducing tax liabilities in a given situation.
CONCLUSION
If you have any questions about the above ideas for improving your bottom line, I welcome you to give me a call or send me an email for a clarification or more details. I wish you all the best in 2011, and hope it will be your most profitable year yet.
Warm Regards,
Michael J. Leonard, Esq.
Attorney at Law
San Diego Corporate Law
www.sdcorporatelaw.com
Find me on Facebook: http://www.facebook.com/SanDiegoCorporateLaw
The following are some of my suggestions for increasing net income by reducing costs.
START WITH GOOD FINANCIALS
Good financials not only show how much money is coming in and out of a business, but in great detail show WHERE the money is coming from and WHERE the money is going. Without good financials, it will be impossible to know which cost cutting efforts will significantly cut into sales and which will have little or no effect on sales.
Start looking at the financials. If good financials are not available, hire a bookkeeper or accountant to set up a proper accounting system and generate them. Financials will only cost a couple hundred dollars per month for most businesses, and this investment could be worth thousands of dollars per month if the information is used properly.
If you do not currently use an accountant or bookkeeper, call me or send me an email and I will gladly suggest a few professionals I trust.
ONLY KEEP THE RIGHT EMPLOYEES
Employees are the usually the largest single business expense. While most businesses cannot survive without employees, cutting costs while increasing sales is about having the right employees in the right positions, and not necessarily just fewer employees.
Every person drawing a check from a business needs to be doing one of two things: (1) Making the business money; or (2) Saving the business money. Identify how each employee is either making the business money or saving the business money. It is not always obvious.
For example, do not fire a receptionist doing tasks for $10 per hour when other staff will have to do this work at $25 per hour. The receptionist is saving the business money.
A contrary example is that of a salesperson who does not up-sell or cross-sell. This salesperson is not making the business money because anyone can answer simply answer a phone and take orders from customers. Replacing this salesperson with another, more motivated salesperson who actively seeks out new sales and works to increase the amount of goods or services sold in each sales transaction is an example of a salesperson who makes money for a business.
ADVERTISE WITH A NARROW FOCUS
Advertising is another typically large business expense. Advertising smarter by narrowing the focus of distribution will reduce costs while giving a greater return on investment for each advertising dollars.
Figure out where customers are located and direct advertising there. Is a client going to drive from their home or office to a frozen yogurt shop miles and miles away, or will they just go to the closest place to get what they want?
Also think about the media in which advertisements are placed. Do not advertise hearing aids on the internet or snow boards in a newspaper. Understand how to best reach customers, and quit wasting money advertising in the wrong media.
If it is unclear where clients are coming from or how they learned of the business, just ask them at the first contact or point of sale.
FASTER INVENTORY TURNOVER
Streamlining procurement is another way to save big money and free up capital. Many businesses get sucked into buying too much product from distributors offering price breaks on quantity. Yes, a 10% price break might be extended for restocking in bulk, but if the inventory does not turn at least every 30 to 90 days (this is industry dependent), too much capital is tied up in inventory and increases costs in several ways.
Costs associated with slow inventory turnover include spoilage, obsolescence, cost to insure inventory, and cost to warehouse inventory. Spoilage and obsolescence will cause inventory to be discarded or sold at deep discount, while high insurance premiums and high rental rates also create unnecessary drains on gross income. If too much of a perishable or trendy item is stocked, when the perishable spoils or when yesterday’s trend is no longer selling, that inventory must be sold at a deep discount (if you are lucky) or thrown in the dumpster; a costly waste of your money.
Consider using necessities or options contracts to secure the ability to purchase at a discount and never run out of inventory while at the same time not purchasing more inventory than necessary at any given time.
PAY LESS TAXES
Every business needs a solid strategy to deal with taxes. While paying taxes is unavoidable, there are options available to businesses to reduce tax liability.
Classification of a worker as an independent contractor rather than an employee passes the duty to pay employment taxes and workers compensation insurance to the independent contractor. While this savings is significant for the business, not every worker is eligible for classification as an independent contractor and improper classification of a worker as an independent contractor can result in expensive fines and other penalties from the Internal Revenue Service, so get some professional advice before reclassifying any employees.
The type of business entity used to conduct business can also have a significant impact on tax liability. For example, sole proprietorships are typically more heavily taxed than corporations organized under Subchapter “S” of the Internal Revenue Code. These “S-Corps” allow the business owners to split income between salary subjected to employment taxes and net income not subjected to employment taxes; a difference of 15.3% in tax liability.
A business attorney can help determine which business entity will be best suited for reducing tax liabilities in a given situation.
CONCLUSION
If you have any questions about the above ideas for improving your bottom line, I welcome you to give me a call or send me an email for a clarification or more details. I wish you all the best in 2011, and hope it will be your most profitable year yet.
Warm Regards,
Michael J. Leonard, Esq.
Attorney at Law
San Diego Corporate Law
www.sdcorporatelaw.com
Find me on Facebook: http://www.facebook.com/SanDiegoCorporateLaw
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