Windward V1.6 from Howell Legal: Back to School | The Employee-Contractor Tango
A monthly newsletter from the team at Howell Legal for founders and leaders of ventures on the rise
📣 Rallying Cry: Back to School! 🤓
Here at Howell Legal, we love September. And it’s not just because of the crisp New England air and pumpkin-spiced everything. The world of doers and builders returns from vacations en masse, with a collective burst of energy that’s unmatched throughout the year. It’s time to close those customers, deals, partnerships, investments, and acquisitions before year-end. And let’s be honest: It’s already the Fourth Quarter. Thanksgiving through New Year’s is another dead zone. You’ve got 8 weeks left in 2023.
Get.
It.
Done.
-Ryan
1. 🤓 Frequently Given Advice
Obligatory Disclaimer: Even if we are your lawyers, the following does not constitute legal advice and is for informational purposes only.
The Employee-Contractor Tango 💃
Of the many, many hassles that startups face, the requirements for how companies have to treat employees in the U.S. are some of the most challenging (more on these requirements below). Many clever founders think that they can avoid the trappings of “employment” simply by paying their team members as “1099s”—that is, reporting their compensation on IRS Form 1099, which is the form applicable to payments to independent contractors, rather than Form W-2, which is the form applicable to employees. This approach, while certainly enterprising, gets the analysis exactly backwards.
As our programmer friends might say, whether a team member is an employee or an independent contractor is an “output,” not an “input.” In other words, you don’t get to choose which label to apply and which set of rules you have to follow. Instead, state and federal law looks at the specific facts and circumstances of the individual’s engagement to decide whether they should be considered an employee or a contractor. It’s then up to the company to correctly classify that person as an “employee” or “independent contractor” and, if they’re an employee, comply with the applicable rules (we’re getting to those, I promise).
Given the additional burdens for employees, wouldn’t it be nice if there were a bright line rule indicating who’s an employee and who’s an independent contractor?
We should be so lucky.
No, this is a multifactored analysis that varies case-by-case. Some general principles do apply if you’re aiming to have someone considered an independent contractor:
Fewer hours is better than more
It's better if the service provider controls the means through which they deliver service, even if you control the ends
The work they do should be of a kind that they provide for other businesses
They should be working with their own equipment
They should not be holding themselves out as having a permanent position with the company
So, your full-time “Vice President of Marketing” who works under the direct supervision of your CEO with a company-issued laptop is almost definitely an employee under the eyes of the law. On the other end of the spectrum, the freelance web designer that you found on Upwork who codes your new site for a couple of hours a week on their own equipment can probably be safely considered in independent contractor. Between those extremes, it’s likely a more challenging analysis.
So, why does the employee vs. independent contractor distinction matter? The rules vary state-by-state, but employment generally requires:
Paying at least minimum hourly wages (i.e. 🚫 equity-only comp)
Paying increased wages for overtime work
Paying payroll taxes
Withholding required taxes
Holding workers’ compensation insurance
Paying into state unemployment and disability funds
For the ambiguous cases, where your team member might be an employee or an independent contractor, you’ll have to weigh the added burden of considering someone an employee against the risk of misclassification.
Misclassification is the treatment of an individual as an independent contractor when they should have been treated under the law as an employee. There is some risk that a state or federal government could independently initiate an investigation and find a company liable for late fees and penalties for misclassification. The greater risk, however, is that a disgruntled former team member could report misclassification. Companies that are lax in classifying borderline team members as independent contractors often find themselves giving generous severance offers to folks that they terminate so that they can get a waiver and release agreement to protect against a claim of misclassification.
In the end, we’re sensitive to the struggle. Just paying minimum wage can be a deal-breaker for bringing on a new, critical team member. We advise our clients to balance the costs and risks soberly, recognizing that there might be a mess to clean up if you go the independent contractor route and it doesn’t work out.
2. 📅 Reminders and Deadlines
🪦 Are you looking to wind down operations of a company and start a new venture? As we enter Q4 (see above 😉), you may want to consider completing any corporate dissolutions by the end of the year. This process looks different depending on what state you formed your company in, but formally dissolving by the end of the year may save you hundreds of dollars in taxes and state fees that you may owe if your company remains active into 2024.
👋 Along the same lines, it is also a good time to check the states in which you are registered to do business. If you’re registered in a state, but you no longer have employees or are not conducting business there, you can withdraw your registration and save another year’s worth of taxes and fees.
3. 📰 Team News
One of the things that we try to do differently from other law firms is prioritizing client experience. We know that many of our clients are first time founders that haven’t had corporate attorneys before. Most of the rest are coming to us because they’ve had bad experiences with other firms. So, what do you do to acquaint users with a product when they’re either bring no experience or negative biases to the table?
Give them a User Guide!
Our User Guide covers topics like:
Projects and questions that we support
Expectations for responsiveness and turnaround time
Billing practices
Company values
Team members and contact information
How to send us projects and ask questions
Reference materials and DIY resources
This is a public document that’s regularly updated and can be revisited whenever clients need it. Please check it out. It’s very much a Version 1.0, so please send us feedback if you have any thoughts.
4. ⚓RI Happenings
Four words: Startup Week Rhode Island
Our friends at RIHub have done an extraordinary job assembling 8 days of diverse, exciting events from September 29 - October 6, spotlighting the best in entrepreneurship and innovation that The Ocean State has to offer. Head over to their Events Calendar. If you’ve found this way to this newsletter, we bet there’s something there for you!