Matthew Staub

The Cost of Converting Independent Contractors to Employees

While Uber may be receiving the lion’s share of the attention on the topic, there has been no shortage of court rulings, IRS audits, and labor decisions on the issue of workforce misclassification. With a noticeable shift towards government agencies determining certain personnel are employees, it has made it increasingly difficult for employers to feel comfortable classifying a worker as an independent contractor, even when it appears to be the correct decision. This has caused many employers to revisit their corporate policies concerning the treatment of independent contractors, sometimes resulting in the conversion of the employer’s workforce.

Employers can choose to be proactive or reactive when dealing with these workforce decisions. Reactive employers that are subject to dealing with audits and wage claims, while the proactive ones conduct an in depth financial and practical analysis of converting its independent contractors to employees. Being proactive will lessen the scrutiny of the Federal and State agencies, but employers are often surprised by the added costs of hiring and maintaining employees.

Below are some costs that employers can expect to incur when implementing a conversion from contractors to employees.

Minimum Wage

One of the biggest employer shifts from contractor to employee is the actual pay to the worker. Contractors are easy; the employer agrees to pay the contractor a set amount over a set period with little opportunity for problems to arise. Conversely, there are many payment considerations surrounding employees, the least of which is assuring that employees receive minimum wage.

Employers must pay employees minimum wage for all compensable time. This rule applies to both hourly and salaried employees. While many employers do not consider this to be a major concern, employers should remember that it must pay minimum wage for all hours on the job, such as travel and training time.

Generally speaking, when an employee is required to travel for work, that time is compensable. This includes time spent driving, or as a passenger on an airplane, train, bus, taxi, or car, in traveling to and from an out of town event, and time spent waiting to purchase a ticket, check baggage, or get on board, is compensable. It’s easy to see how these hours can quickly add up. Time spent training is compensable unless the activity is voluntary, it occurs outside of regular work hours, it is not directly related to the employee’s job, and no productive work is performed during the activity. Depending on the type of work required by the employee, employees that travel or require extensive training can create major havoc to an employer’s bottom line.

Breaks and Overtime

Lunch breaks, rest breaks, and overtime are another major consideration for employers. In California, an employee is entitled to a meal period of at least 30 minutes after working five hours (unless the total work period is no more than six hours) and is entitled to a second meal period of not less than 30 minutes if the employee works for more than 10 hours (unless the total hours are under 12). The meal period may be waived, but such waiver must be in writing by mutual consent of both the employer and the employee. Merely providing a lunch break may not be enough, as employers must also follow specific rules for how the meal break is provided.

Employers must authorize and permit a 10 minute paid rest period for every four hours worked or major fraction thereof. If employers do not authorize or permit a rest period, it will be obligated to pay the employee one hour of pay at the employee’s regular rate of pay for each workday that the rest period is not provided. Either way, rest periods are compensable time for employees.

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If classified as nonexempt employees, it is possible that such employees may incur and be entitled to overtime pay. This pay is 1.5 times the employee’s regular pay for all hours worked in excess of eight hours in a day or 40 hours in a week, and double the employee’s regular pay for all hours worked in excess of 12 hours in a day. The increased pay is not the only issue for employers surrounding overtime pay, as there can also be added time costs of determining who qualifies for overtime pay and monitoring employees to ensure they are working under the overtime threshold, if employer preferred.

Employee Expenses

A major shift for employers when dealing with employees as opposed to contractors is the requirement for employers to pay for employee expenses. Most contractors will be required to pay for their own expenses, but employees are the opposite.

Employee expenses can add up quickly with items such as meals and lodging, travel expenses, and equipment and tools. Depending on the type of business, workers that frequently travel or workers that require expensive equipment and tools to do their job are going to create major financial strain for employers. The requirement that employers must pay or reimburse employee expenses is liberally construed, so employers can plan on covering many costs it may not have expected to cover.

There have been recent legal opinions that equipment costs, such as the costs associated with cell phones used for both personal and business use, must be reimbursed by an employer. This was the case even where the use of the cell phone had no real marginal costs, especially in the age of unlimited minutes. This trend could stretch beyond cell phones so employers should be wary of the tools and equipment employees require in performing their job.

Health Care and Employee Benefits

Employers are required to provide health insurance coverage if it has at least 50 full-time employees or equivalents. For these employers, the analysis doesn’t stop there, as additional time and money is spent selecting the right health care plan and navigating the complex health care laws. Problems can also arise for employers with less than 50 employees, because although they may not be legally responsible for providing health care, these employers could experience issues with employee retention if an employee’s expectation is to receive health benefits.

Some states have mandated paid sick leave for employees. For example, the minimum requirement for paid sick leave is 24 hours in California, which can cause its own problems in terms of having to pay a second employee to cover the sick employee. As with health care, employees may expect other benefits such as vacation and holiday pay, personal days, and retirement contribution. While these employee benefits may not be required, making employees happy drastically helps retention and reduces the cost of having to find and train new employees.

Insurance and Other Costs

There are many other new expenses that an employer is going to encounter when converting its workforce to employees. Items such as payroll taxes, workers compensation insurance, and general liability insurance, to name a few, will all come into play with employees in the mix. These expenses can vary greatly depending on the type of work of the employer, so when possible, an employers should obtain quotes early in the decision making process of pursuing an employee conversion. Take Uber for example. In addition to the standard insurance required just for having employees, it would have to consider whether auto insurance for the drivers was prohibitive enough to necessitate change to its current business model.

Conclusion

The heavy focus on workforce misclassification has caused many employers to think twice about continuing to label certain personnel as independent contractors. One way to bypass this concern is by converting the contractors to employees, but as you can see, this is no easy task. While the items discussed above will apply to most employers, each employer still presents a different set of facts, making the conversion analysis case specific. Proactivity is key and employers should begin determining the costs associated with converting its contractors to employees as soon as possible, taking into consideration whether the conversion makes sense from both a financial and practical perspective.

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