When navigating a ship along the coast, a captain consistently looks for the safest harbor to dock their ship.  Why take the risk of damaging your valuable ship and crew?  However, many who are steering their business through the stormy seas of entrepreneurship will take unnecessary risks.

One of the potential risks of owning a small business and having employees, is the fateful day when they may get hurt while on the job.  Hopefully it is nothing too serious, but it’s important to always prepare for the potential that an injury could occur.

The Scary part

First, let’s not hope you have been paying your ’employee’ under the table and trying to call them a sub-contractor.  Remember, if they look like an employee, act like an employee and you pay them as if they were an employee…guess what?  They’re an employee!!

Here’s the scary part.  If they really are an employee, and you haven’t been treating them as such, you have two major problems:  a) Workers Compensation won’t be there for you and moreover you just stirred up a hornets nest, and b) you could be personally liable for the injury- even if you have a corporation or LLC.

Workers Compensation is the ‘fund’ or ‘insurance’ plan that employers are supposed to use to cover the potential injury of an employee, and believe it or not, it protects YOU more than it helps the employee.  It limits the employee’s claim to the Workers Compensation Fund and you can generally avoid any more liability (assuming you weren’t negligent is some form or fashion).

But why could you be personally liable?  Because NOT carrying Workers Compensation can arguably be considered ‘negligent’ and thus you just exposed yourself to personal liability and to heck with the ‘corporate veil’ and your company protection.

The Safe Harbor

The easiest step and action to take is to treat your employee like an employee.  Don’t be frustrated by the payroll withholding and extra fees.  Plan on about 10% on top of the hourly rate or salary (for example, if you are paying $15 an hour, plan on it costing you $16.50 in withholding’s and Workers Comp).  However, it’s important to note, the riskier the business, the more higher the rate could be.

When you are paying into the Workers Compensation Fund you are carefully assessing potential risks and being cautious.  The Fund is their to provide a safe harbor and protect your business. An injury of a ‘cash worker’ could destroy your business.

How do you define an Employee?

The IRS and Workers Compensation Laws essentially use three characteristics to determine the relationship between businesses and workers: Behavioral Control, Financial Control, and the Type of Relationship.

Here are the questions and issues to consider when evaluating your workers:

  1. Behavioral Control covers facts that show whether the business has a right to direct or control how the work is done through instructions, training or other means.  Does the business provide instructions to the worker about when, where, and how he or she is to perform the work?  Does the business owner provide training and the services integrated into the principal’s business operation?  If the answer is generally ‘yes’ to these questions- they are an employee.
  2. Financial Control covers facts that show whether the business has a right to direct or control the financial and business aspects of the worker’s job. Does the business owner hire, supervise and pay assistants to the worker?  Does the business owner realize the profit or loss as a result of the worker’s services?  Again, if the answer is generally ‘yes’ to these questions- they are probably an employee.
  3. The Type of Relationship factor relates to how the workers and the business owner perceive their relationship.  Is work required to be completed at the business owner’s premises?  Does the owner have the right to ‘fire’ the worker and would it be termed as such?

If you have the right to control or direct not only what is to be done, but also how it is to be done, then your workers are most likely employees. Bottom line, stay on top of this issue and don’t get lazy or careless thinking you can pay folks “under the table” and your not risking all your assets and livelihood.

The IRS is lurking in the water as well

The Internal Revenue Service has a vested financial interest in what your worker is actually defined to be: Employee or Sub-Contractor.  The reason being, the business owner must withhold Federal, State, and Employment taxes if the worker is an employee.

Many entrepreneurs try to get around this requirement to withhold by simply stating and then believing their worker is a Sub-contractor.  However, if the IRS audits you, which this is an issue they regularly do audit, and you lose, the taxes and penalties are serious.

Moreover, the IRS has a ‘watch dog’ to help find business owners violating this law. The IRS will rely on State Unemployment Boards, and Workers Compensation auditors to turn in business owners to the IRS.  Bottom line- Beware!!

A small business owner should be aware of the risk and find the safe harbor for operating their business. Don’t navigate the seas without Workers Compensation.

Mark J. Kohler is a CPA, Attorney, Radio Show host and author of the new book “The Tax and Legal Playbook- Game Changing Solutions For Your Small Business Questions”  and “What Your CPA Isn’t Telling You- Life Changing Tax Strategies”. He is also a partner at the law firm Kyler Kohler Ostermiller & Sorensen, LLP and the accounting firm K&E CPAs, LLP. For more information visit him at www.markjkohler.com.m.