In my practice, I occasionally come across small business owners that appear to be confused regarding the difference between an independent contractor and an employee. Oftentimes, this confusion is fueled by a misguided belief that it is better to “1099” everyone that performs services related to the operation of their business and thus avoid those pesky payroll taxes and workers’ compensation insurance premiums.
This shortsighted view ignores two key facts: (1) a person either is an employee or is not, regardless of what the business owner decides to call them; and (2) workers’ compensation insurance is a business owner’s FRIEND. To illustrate this point, let’s look at the cautionary tale that played out before the Idaho Supreme Court in Allen v. Reynolds, 145 Idaho 807 (2006).
At the time of the case, Anne Reynolds had owned and operated a horse ranch in Elmore County ironically named Why Worry Ranch since 1983. In 2000, Ms. Reynolds wisely chose to convert her ranch from a sole proprietorship to a limited liability company, Why Worry Ranch, LLC (“WWR”). Unfortunately, like so many single-member LLC owners, Ms. Reynolds apparently overlooked the distinction between herself and the LLC when it came time in early 2004 to transfer her workers’ compensation policy from her previous insurance brokerage to the Idaho State Insurance Fund (“SIF”). As the Court noted, Reynolds filled out the necessary paperwork while sitting atop her horse and later acknowledged that “she probably did not read everything on the application and did not notice that WWR was not mentioned anywhere on it.”
Although when Reynolds paid for the policy with a check drawn on WWR’s bank account, an astute SIF underwriter noted the discrepancy and attempted to clarify who the owner of the policy should be, Reynolds’ insurance agent was out of the office for two weeks so the policy was written under Reynolds’ name as “sole proprietor”. Later, in March of 2004, Reynolds was asked by an SIF underwriter to confirm that the policy was only for Reynolds individually and not WWR. Reynolds refused to sign the acknowledgment form, responding simply, “I am WWR.”
Meanwhile, SIF was also attempting to get required payroll reporting from Reynolds in order to calculate the appropriate policy premium and sent Reynolds a reporting form along with a caution that the policy would be cancelled if the information was not provided. SIF sent Reynolds a reminder letter in April of 2004 and finally sent a certified notice of cancellation on May 11, 2004 due to the lack of response. The policy was cancelled the end of that month.
To make matters worse, although SIF offered Reynolds a chance to cure the lapsed policy within 30 days of cancellation by submitting the requested payroll records, that grace period came and went without a response. Finally, 31 days after the policy was cancelled, SIF received a “payroll summary” prepared by the WWR bookkeeper that failed to include much of the required information.
On July 2nd, SIF made one last attempt to get the policy re-instated and properly transferred from Reynolds to WWR, giving Reynolds until July 8th to get the necessary paperwork completed. No dice. To be fair, several of the missed deadlines and inadequate reporting were the work of WWR’s bookkeeper who, as it later turned out, had embezzled approximately $350,000.00 from WWR over a period of five years. (Did I mention the name of the business was Why Worry Ranch?)
Just six days later, on July 14th, one of WWR’s employees severely injured her thumb while tying up a horse. The thumb was later amputated and the employee ultimately filed a workers’ compensation claim with the Idaho Industrial Commission.
Based on the foregoing facts, the Idaho Supreme Court held that WWR did not have a workers’ compensation insurance policy in place at the time of the employee’s accident and, therefore, could not avail itself of that statutory shield from direct liability for the employee’s injury. Although the issue of the extent of WWR’s or Reynolds’ liability to the employee was not before the Court in that case, one can safely presume that without the shield of a workers’ compensation policy to cover the loss, Why Worry Ranch, LLC might well have decided to reconsider its name.
The moral of this story is, as a business owner, instead of looking for clever ways to skirt paying for workers’ compensation insurance, you should welcome the protection it affords your business as the sole remedy for an injured worker’s damages.
So, how to decide if a worker is truly an independent contractor or a covered employee? In Idaho, the test for workers’ compensation coverage is based on four factors:
- The degree of the business owner’s right to control the worker’s conduct and performance of a job;
- The method of the worker’s payment by the business owner;
- Whether the business owner or the worker provide the worker’s major items of equipment necessary to perform the job; and
- The right of either party to terminate the work relationship without contractual liability.
These factors are discussed in more depth at www.idahobizhelp.org/emp_vs_contractor.htm.
(In addition, the Internal Revenue Service has a wealth of information on how to properly classify workers for tax purposes, including a virtual Small Business Tax Workshop: http://www.irsvideos.gov/virtualworkshop/.)
As the Idaho Industrial Commission notes in its brochure, “Independent Contractor or Employee?”, improperly classifying employees as subcontractors to avoid paying workers’ compensation premiums is on the rise in Idaho, despite being punishable by the assessment of potentially large premiums following an audit, policy cancellation, civil or criminal charges, fines and jail time. But, as the unfortunately-named Why Worry Ranch belatedly discovered, having and maintaining workers’ compensation insurance just makes good horse sense.
Molly O’Leary represents business and telecommunications clients throughout Idaho, and is the Managing Principal of BizCounselor@Law, PLLC. In addition, she is a Past President of the Idaho State Bar and a current member of the Statewide Advisory Counsel for the Idaho Small Business Development Center. You may follow her on Twitter: @BizCounselor.