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Employee Leasing to Limit Workers' Compensation and Other Liability

Over the past several decades it has become increasingly expensive to hire and maintain employees. A large part of the expense relates to government programs and reporting requirements, but accounting costs related to employees have also risen. Small businesses have been especially hurt and have sought ways to reduce costs.

One method of reducing costs has been to hire independent contractors instead of employees. Theoretically, independent contractors are not employees. For this reason, hiring independent contractors may allow an employer to avoid employment requirements and regulations associated with hiring regular employees (such as workers’ compensation insurance, payroll withholding requirements, and related employment taxes).

Independent Contractor or Employee

Employers frequently attempt to label employees as independent contractors in order to escape the duties and responsibilities they would otherwise owe if the individual were characterized as an employee. In many instances, however, the U.S. Internal Revenue Service (IRS) attacks the characterization of “independent contractor” status.

The IRS uses a variety of “factors” to determine a worker’s true status. Most focus on the control exercised by the employer over hours, where and how the work must be done, supervision, quality control and other factors. When the IRS is successful, the employer may be required to pay any unpaid back payroll taxes and any penalties for such unpaid taxes.

Temp Agencies and Professional Employer Organizations

An alternative has been to use “temp” agencies. Such agencies employ workers and send them to work for others on a temporary basis; the worker remains an employee of the temp agency, relieving the employer of many duties. A similar, more recent phenomenon are professional employer organizations (PEOs). PEOs commonly become the employers and “lease back” the company’s employees on a long-term basis.

PEOs that “lease” employees to customers may then be able to procure things such as group benefits and workers’ compensation coverage at reduced rates, due to their larger numbers of employees. To induce employers to utilize their services, PEOs, in effect, pass some of these savings along to employers/customers who lease workers from them. The PEOs also usually handle payroll and other accounting services for leased employees at significant savings to the employer. Leased employees typically cost more than independent contractors, but less than full-time employees.

Risks of Using Leased Employees

As a practical matter, if employment and/or tax laws are violated, the employers using PEOs may also be held liable as “joint employers.” In addition, even though a leased employee is not technically on the employer’s payroll, the employer may still be legally obligated to provide a safe and harassment-free workplace and avoid illegal discrimination. Thus, not all duties owed by an employer to an employee are eliminated by using a PEO.

Employers may be able to decrease the risk of being considered “joint employers” with their PEOs by limiting supervision and control over leased workers and avoiding using such employees for extended periods of time. A clear contract that specifies each worker’s role and status as a leased employee may also help. In addition, employers should ensure that correct comprehensive general liability and workers’ compensation insurance are maintained by the PEO. In the final analysis, however, it may be very difficult for an employer to avoid certain liabilities, such as responsibility for unpaid payroll taxes.

PEOs are regulated by law in many states, and Congress has also considered a number of measures to regulate and clarify their status. Further legal limitations and requirements related to using a PEO may therefore exist.

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