Is a worker an employee for whom the employer must withhold taxes and cover with workman’s compensation insurance or is he an independent contractor for whom there is no such responsibility? What is an employee? For federal purposes there are complicated common law (court made) rules, but the bottom line is usually that if the engaging party has the right to control the details of the work being done, the worker is an employee. The other falls into the category of an independent contractor agreement.
In a competitive business environment there is strong temptation to treat workers not as employees, but as independent contractors. Payroll costs for an employee can be 50% higher for an employee than for an independent contractor because the business must pay payroll taxes and workman’s compensation insurance premiums for employees.
If competitors are not paying the payroll taxes and the workman’s compensation premiums, their labor costs will be 50% lower and work can be bid at much lower rates. The playing field is not level. The risk is that when a business fails without paying payroll taxes, its responsible officers (that includes anyone who participates in the decision not to pay taxes) are personally liable. That liability is not dischargeable in bankruptcy.
I worked on a case in which our bilingual client got contracts to do brick work for major homebuilders and subbed the work to brick masons who were treated as independent contractors. IRS took the position that the bricklayers were employees and that our client owed more than $2,000,000 in delinquent taxes. We settled on the second day of trial for $200,000 and an agreement to treat the workers as employees in the future.