Independent Contractor Compliance Blog

When keeping employee records, you don’t want to clutter up your files with old papers or terabytes of meaningless data. However, there are some documents (paper and digital) you should store in a safe place for protection should you ever face an independent contractor (IC) misclassification challenge.

There are numerous incidents that can trigger an IC misclassification challenge at a later date. They include:

• Being audited by a tax agency

• A former consultant files for unemployment insurance

• A current worker files a worker’s compensation claim for an injury

• A current or former consultant files a lawsuit for overtime, fringe benefits, etc.

In each of these situations, and many others, you will need evidence to prove you did everything right and the consultant was truly in business for himself.

Here are a few of the business documents you should safeguard if you utilize ICs:

• The written contract

• The statement of work, or description of the deliverables

• Timetable for deliverables

• Milestones completed

• Circumstances of how the job ended (documentation showing successful completion of work, reasons for early termination, etc).

• Payment schedule (amounts paid, when paid, and what payments were based upon).

• Performance reviews: Were you satisfied with the work and would you re-engage this contractor?

Once this documentation is collected, it needs to be stored in a safe location for at least five years after the project ends and after the consultant is gone. We recommend this because challenges can come several years after an engagement concludes. By then, the individuals who had personal knowledge of the project may be no longer available, or their memories may fade. Also, the contractor may not be available. This makes reconstructing data at a later date costly, and it can also create questions about accuracy.

The best practice is to properly manage your consultant population and protect your business by gathering the necessary documentation when it is fresh and readily available.

Disclaimer: Given the general nature and context of this article, the material presented should not be relied upon or construed as either tax or legal advice. For specific information on recent developments, the effects of particular factual situations or of a particular law in regards to your business, or before making decisions based upon this presentation, you should obtain the opinion of a qualified expert.

A recent article cited a survey of more than 1,400 CFOs from U.S. companies that have twenty or more employees on staff.  The CFOs were asked: “What common mistake do companies make most in managing their employees?”

Here are the three top responses:

• Lack of communication between staff and management

• Lack of recognition and praise

• Lack of training, development, and/or educational opportunities

The article went on to give advice on how to better communicate with, provide recognition to and train staff. As good as this advice may be for managing your employees, from an independent contractor (IC) compliance point of view, doing this with your ICs puts you at risk of converting them into misclassified workers. Here’s why:

• Communication: Insuring your ICs are in the “company’s communication loop” for such things as staying abreast of organizational information, changes in company policies, updates on the company’s financial performance, and new initiatives not related to their project or about other group projects not related to theirs tends to draw them deeper into your company family and into your control. This information is usually distributed in company-wide internal e-mails or during staff meetings. Treating contractors the same as your employees tends to make them look and feel more like your employees. This opens the path to misclassification.

Asking employee-staff: “Do you have the right resources to perform your work effectively?” is another good practice, especially if you then try to provide it. ICs, however, are ideally supposed to provide their own resources to accomplish the job. Providing ICs with resources (tools, supplies, equipment and workspace) tends to make them look like an employee.

• Lack of recognition and praise: The article recommended you take time to praise workers who go above and beyond, call attention to their successes and contributions during staff meetings or via company-wide e-mails, and be sure to copy relevant managers. Doing this for employees is an excellent method of motivating your best workers. However, doing this for you ICs is the path to misclassification. ICs need to receive timely payment for a completed job and possibly receive a good recommendation for their next potential client when the job is successfully completed. These should be praise enough for a true independent contractor.

• Training: The lack of training, development, and/or educational opportunities will definitely create an unhappy employee. It doesn’t take much management experience to know providing these opportunities for your staff will improve morale and increase productivity. However, providing these opportunities to your ICs is a major step towards misclassification.

The courts have viewed training as a method of instructing the worker how to perform the details of the work, which is viewed as evidence of the right of direction and control — the primary deciding factor in common law employment determinations.

The underlying tenet here is that employees and ICs are mutually exclusive sets. Almost without exception, you cannot have them doing similar work under the same environment and consider them to be different under common law. You just cannot treat your ICs the same way you treat your employees. It makes them look like your employees and usually ensures creating misclassified workers.

Disclaimer: Given the general nature and context of this article, the material presented should not be relied upon or construed as either tax or legal advice. For specific information on recent developments, the effects of particular factual situations or of a particular law in regards to your business, or before making decisions based upon this presentation, you should obtain the opinion of a qualified expert.

According to a recent survey, The Hackett Group, a business consulting company, found that many human resources (HR) departments are not doing an adequate job in recruiting and qualifying high-end talent for their companies.

The article reported that one of the effects of this shortcoming is a “talent crisis” in vital high-end business functions such as finance, information technology and procurement. The report indicated that there are many highly skilled people looking for new projects, but HR departments don’t have the resources to find and screen them. This is especially true for short-term needs or special projects that are not part of the mainstream, permanent employee hiring process.

The study examined six areas of talent management, including recruiting and staffing. According to the report, poor HR support is causing many businesses to experience a hard time finding and retaining the right talent. “Companies aren’t satisfied with the support HR is providing,” says John Cooper, associate principal and HR Advisory Program leader at The Hackett Group. The primary reason given for this shortcoming? Limited budgets.

Does this sound familiar? You need top talent and your in-house HR department doesn’t have the resources to provide the recruiting and screening you need. One solution is to turn to a third party vendor that is set up to provide this special service efficiently, at a lower cost – a company that specializes in providing skilled project managers and teams of subject matter experts for important, temporary projects.

If you choose the correct business partner, you don’t need to worry about the following issues:

• Finding highly qualified candidates
• Checking their experience
• Vetting their suitability for the role
• Verifying technical qualifications
• Conducting background checks
• Ensuring delivery of results

Once the ideal candidate(s) is/are selected, the on-boarding process is fast and efficient. Also, it is very important to ensure that the proper classification is verified and you will be in compliance with all state and federal laws. Leveraging the top-tier of the contingent workforce is a good way to achieve the results you want from an important project.

Disclaimer: Given the general nature and context of this article, the material presented should not be relied upon or construed as either tax or legal advice. For specific information on recent developments, the effects of particular factual situations or of a particular law in regards to your business, or before making decisions based upon this presentation, you should obtain the opinion of a qualified expert.

What can you say to consultants who don’t qualify as independent contractors (ICs) but insist on being treated as such? This has always been a sticky problem. The consultant insists on being classified as an IC and s/he is the very best choice for your project; however, the project or the consultant simply does not stand up to the scrutiny of an IC qualification.

To protect your company you need to put him/her on a payroll — either yours or with a company like Collabrus. Government enforcement is more aggressive than ever before and if a single consultant is found misclassified, an enforcement agency will assume other workers are also misclassified and investigate all consultants in your company for the full statutory period. The resulting tax assessments, fines and penalties can be very expensive. These issues can come up several years later from a variety of sources including unemployment claims, harassment complaints, routine tax audits, injuries on the job, and even civil lawsuits.

A misclassification finding by the IRS can also have negative consequences for the consultant. The pre-tax, self employed retirement plan could be disallowed, which may lead to an income tax audit of the consultant with additional taxes, penalties and interest assessed for prior years.

There are many clear advantages for the consultant being a W-2 over a 1099. This is especially true if there is a third-party vendor like Collabrus acting as the employer-of-record. For example, ICs injured on the job (car accident, slips in the break room, carpal tunnel, etc.) are on their own for medical treatment. Employee-consultants are covered for these issues.

A W-2 consultant can negotiate his/her own assignment parameters, pay rate, and work schedule; however, quality third-party vendors can help negotiate the legal terms and execute the contract. These vendors can also provide an efficient on-boarding process that shortens the start-to-work time and offers a full-range of employee benefit options to help attract and keep the best, senior-level consultants.

Among these benefits are the following:

• Regular pay schedules. The consultant can count on being paid timely by compensation plans that include: salaried, hourly, fixed project price, or deliverables-driven options

• The payments can be made in semi-monthly paychecks or direct deposits

• Proper employer payments and withholdings are made and requisite taxes paid, so on April 15th there are no surprise penalties for not depositing sufficient amounts during the year, a common predicament for many consultants

• Coverage for general liability; errors and omissions; employer professional liability; and worker’s compensation insurance

 • Medical, dental, and vision insurance, with the option to continue coverage through COBRA when the engagement ends

• Expense reimbursement with an “accountable plan” so consultants can continue to cover business expenses on a pre-tax basis

• A matching 401(k) plan

• A Section 125 pre-tax flexible spending plan

• A Section 132 commuter benefit plan

• Pre-tax dependent care plans

• Unemployment insurance coverage

• Disability insurance coverage (in California)

Employee-consultants, managed by a third-party provider, can also enjoy the continuity of a single year-end W-2 for all assignments, and are able to take their benefits plan with them to their next project.

Disclaimer: Given the general nature and context of this article, the material presented should not be relied upon or construed as either tax or legal advice. For specific information on recent developments, the effects of particular factual situations or of a particular law in regards to your business, or before making decisions based upon this presentation, you should obtain the opinion of a qualified expert.

The Internal Revenue Service (IRS) recently released its new tax gap estimates. The tax gap can be defined as the amount of tax liability that is not paid on time for any reason. The estimated annual amount increased from $345 billion in 2001 to $450 billion in 2006, and a significant portion of the gap can be traced to independent consultants’ (IC) compliance issues.

It is no secret that the use of contingent workers has increased in the last decade, and it is estimated that as much as 26% of the U.S. workforce is now comprised of contingent workers. The IRS has been conducting a national study to update their data and the results are now being analyzed. When this information is reported to Congress, it is likely the IRS will come under new pressure to increase enforcement of IC compliance.

The IRS believes insufficient third party reporting and withholding for some types of payments has contributed to the increase. It reports that compliance is highest where there is third-party information reporting and/or withholding. For example, most wages and salaries are reported on forms W-2 and are subject to withholding. As a result, a net of only 1 percent of wage and salary income was misreported, but amounts subject to little or no information reporting had a 56 percent net misreporting rate in 2006.

The report also indicates that misclassified workers are a direct source of underreported payroll taxes (tax gap estimate is currently at $72 billion—up from the previous amount of $54 billion). However, even this estimate may be too low. At least $120 billion of the tax gap is attributable to individuals and small corporations not receiving either a W-2 or a 1099 and not being subject to withholding. Consultants with their own corporations fall into this category because they do not receive a 1099, making them a prime concern for the IRS.

Regardless, with a tax gap of nearly a half trillion dollars, you can expect Congress to consider even stricter enforcement laws in the future, including IC compliance. The time to prepare for this is before the IRS knocks on your door.

Disclaimer: Given the general nature and context of this article, the material presented should not be relied upon or construed as either tax or legal advice. For specific information on recent developments, the effects of particular factual situations or of a particular law in regards to your business, or before making decisions based upon this presentation, you should obtain the opinion of a qualified expert.

It’s time to file taxes, and there are special advantages and special requirements if you’re an independent contractor (IC). An IC is a small business by definition, and as a small business enjoys tax breaks in the form of deductions for expenses employees do not.

ICs are entitled to most of the same deductions larger businesses take for necessary business expenses. These expenses are deducted up front from your revenue (gross income) to reduce your taxable income. A few examples are:

• Business travel (not reimbursed by your clients)
• Cost of equipment
• Cost of supplies
• Cost of rent for office space
• Advertising and marketing
• Some types of entertainment for clients or prospective clients to gain new business
• If you have employees their wages are expensed against your income
• The costs of fringe benefits for your employees such as health insurance
• The taxes you pay on your employee’s wages such as:
  • The employer’s share of FICA and Medicare taxes
  • Federal and state unemployment taxes

Most ICs carry their own liability insurance to protect themselves and their clients against errors. The cost of this insurance is also a tax deduction.

Did you lose money after paying these expenses? Although not a bright prospect, a bona fide business is subject to the risk of loss. It is possible for an IC to actually lose money. If so, these losses can be deducted against your income to reduce or eliminate any taxes due. If the losses exceed income for the year, some of the year’s losses may be carried over to the next year.

An IC also has some added responsibilities As a self-employed individual you are required to file and pay quarterly estimated tax deposits. This is an area that some small businesses, both sole proprietorships and corporations, fail to do — at least initially. Failure to pay quarterly estimated taxes can result in costly penalties and expose you to some hard collection procedures by the IRS.

Most people consider quarterly estimated tax deposits a complicated area because they are not familiar with the requirements. The estimated deposits may include:

• Your estimated income taxes and self employment taxes (Social Security and Medicare)
• If you had employees it also includes the employee’s share of FICA, Medicare and personal income taxes withheld
• If you are operating with employees in California, there is employee withholding of State Disability Insurance

As an employer you also pay an employer’s share of Social Security, Medicare and unemployment insurance taxes There’s more… The list of advantages and responsibilities of having your own business is much more than what is covered here. Being an employee is relatively simple. Show up, do the job, and get paid. An IC, on the other hand, must be aware of and follow many other legal requirements. You may need an expert to help you meet these requirements. Many leave meeting these requirements to a CPA, whose cost of service is also a tax deduction.

Good luck with your taxes this year!

Disclaimer: Given the general nature and context of this article, the material presented should not be relied upon or construed as either tax or legal advice. For specific information on recent developments, the effects of particular factual situations or of a particular law in regards to your business, or before making decisions based upon this presentation, you should obtain the opinion of a qualified expert.

Most enforcement agencies consider training an individual on the job as proof that a consultant or independent contractor (IC) is working as an employee. When you train someone in the workplace, you are instructing them on the details of how you expect them to do the job. In fact, a major piece of evidence against businesses facing a misclassification challenge from either the government or in a civil case is a written procedure manual, policy memo, or other documents detailing how work will be performed. Such documents become proof of direction and control — the primary common law factor in most states and for the IRS.

You may argue that some training is necessary so the new person will fit in with the regular staff and know company policies and operations. You might think it is not reasonable to expect an outsider to come in and work without some type of orientation and training. It’s true, some orientation to ensure your new IC knows the location of the restrooms, office hours, security requirements, and other general information required is normal and will not transform your consultant into a misclassified worker.

However, training covering detailed procedures and information about how the job should be conducted starts to move the relationship toward direction and control. For example, it’s reasonable to familiarize the consultant on proprietary software and expect him to work within that framework when writing programs or acting as a user; however, the further you go down this road — the more detail procedures you require him to follow, or instructions you provide — the closer he approaches employee status. Clearly, the training issue can be tricky. One moment you have an IC, the next you have gone too far and converted the worker to a misclassified employee.

How can you know when this happens? Typically, employees are trained, and ICs are recognized experts and need no training. ICs bring expertise to the table your company doesn’t have. If you need to train a worker about how to do the job, then it makes them less of an expert and gives you more control over the details of how they will perform for you. This training shows direction and control and could be considered as a method of communicating detailed procedures and expectations of performance on the job.

Another indicator is when you make training mandatory. Authority to make training mandatory shows actual application of direction and control and is a strong indicator of an employment relationship. In addition, paying the consultant during training hours becomes the smoking gun in a tax hearing. This could be interpreted as “I’m paying you to learn this information and I expect you to do it my way when you perform services for me.”

Bottom line: Training alone will not be enough to convert an otherwise IC into a misclassified employee. All the common law factors that describe the working relationship must be weighed and considered as a total picture before you can correctly determine if someone is an employee or IC. That’s why it takes an expert to make the call.

Disclaimer: Given the general nature and context of this article, the material presented should not be relied upon or construed as either tax or legal advice. For specific information on recent developments, the effects of particular factual situations or of a particular law in regards to your business, or before making decisions based upon this presentation, you should obtain the opinion of a qualified expert.

The U.S. Department of Labor (DOL), working with some state employment agencies, is offering training that provides “dislocated workers the opportunity for early re-employment” through self-employment. This means that if someone has lost his/her job and wants to create a small business, there is a federal program than can help.

The Self-Employment Assistance Program will pay a “self-employed allowance”, instead of regular unemployment insurance benefits, to help unemployed workers establish their own independent businesses and become self-employed (i.e. independent contractor/sole proprietor). Qualified participants receive weekly payments while the business gets off the ground. Generally, in order to receive these benefits, an individual must first be eligible to receive regular unemployment insurance.

This program was designed for individuals who have been permanently laid-off from their jobs and are identified (through a state’s profiling system) as likely to exhaust regular unemployment benefits. Individuals may be eligible to draw benefits under this program even if they are engaged full-time in what the DOL refers to as “self-employment activities” such as entrepreneurial training, business counseling, technical assistance, and seeking out clients. The self-employment payments are the same as the weekly amount of regular unemployment insurance benefits; however, the participants are freed from looking for employee jobs so they may pursue a new career as a self-employed entrepreneur.

The program is voluntary for states to participate in, and so far only a few states have opted to participate. These states are Delaware, Maine, New Jersey, New York, Oregon, and Washington. Each participating state will likely have slightly different requirements and processes for this program, so if you are interested you should look into the requirements for your state. To find out more about each of these states’ programs, go to: www.servicelocator.org/OWSLinks.asp.

The Self-Employed Assistance Program can be a great opportunity for an individual who lives in one of these states to make a significant career change.

Disclaimer: Given the general nature and context of this article, the material presented should not be relied upon or construed as legal advice. For specific information on recent developments, the effects of particular factual situations or of a particular law in regards to your business, or before making decisions based upon this presentation, you should obtain the opinion of a qualified expert.

In quickly changing times, a continuous upgrading of products and services is often the key to survival. There are numerous examples of companies that failed to heed the law of nature — adapt or perish — and expired. We all can cite examples of businesses that didn’t stay ahead of the curve and are no longer with us, or have fallen so far behind the competition they are no longer relevant.

Chances are your competition is at this moment reinventing and retooling to get ahead of you. It doesn’t matter what you do — make high tech equipment, operate in the health care industry, or sell financial products — your company must continually aspire for leadership.

Of course, your in-house staff knows how to do what you do today really well. However, when significant change is necessary you must find those with fresh ideas and new ways of doing things. In most cases, businesses look outside for sources of innovation and reinvention. External experts can help you develop a new product or service, or establish new processes. In short, they can help save your business.

However, really creative workers often don’t do well in an established business environment for the long term. They want to continually take on new challenges. They are not looking to be permanent employees. That is why most businesses know the best solution is to engage these experts for a specific project, have them provide the fresh expertise needed, and then let them move on when the project is completed.

It can be an ideal solution, if you go about things correctly. Problems typically arise when you don’t have in-house expertise to manage the contingent workers. Your system should:

• Cost effectively onboard contingent workers
• Properly classify them
• Properly manage them during the project
• Properly document the engagement as it progresses
• Properly let them go

Mistakes in any of these areas can create huge legal battles and unplanned liabilities; including civil lawsuits, tax audits and violations under the Fair Labor Standards Act. This is especially true today when the government is looking for additional revenue. The misclassified worker has been identified by federal and state agencies as a rich source of tax assessments, including penalties and interest.

Bottom Line: When bringing in consultants, be sure you are protected. Follow the advice of a qualified expert and do it right.

Disclaimer: Given the general nature and context of this article, the material presented should not be relied upon or construed as either tax or legal advice. For specific information on recent developments, the effects of particular factual situations or of a particular law in regards to your business, or before making decisions based upon this presentation, you should obtain the opinion of a qualified expert.

Today, there are more government tax auditors, larger penalties, and a greater probability of being selected for examination than ever before. This makes it more important than ever that you protect your company from the increasing probability of a misclassification audit, a challenge from a labor law agency or even a civil suit from a disgruntled former consultant. Any of these events can trigger all the others, resulting in large liabilities, damaged company reputations, and a loss of productive time for management.

Here are a few tips to consider that will help to protect your business when engaging an independent contractor (IC):

• Be sure your written agreement clearly defines what the consultant is expected to accomplish, with clear, measureable milestones and deliverables. The agreement should also clearly define when the project will be completed, so everyone knows when the consultant should leave.

• Once the project is successfully completed, the consultant’s services should be terminated. If you want to keep the consultant working for you, then do it right. A common mistake is “extending” the consultant in a series of “new IC projects” that, when viewed in the long term, look like a continuing and permanent relationship. Enforcement agencies typically see such a relationship as employment — not as an IC.

• Your project manager should focus on the end results of the project — the milestones and deliverables — not on the methods and means used by the consultant to achieve them. The procedures followed, hours worked, the type of tools used, or even where the work is performed, ideally should not be a consideration as long as you obtain the end results detailed in the contract.

• It is best if the consultant has an established business prior to coming to you. For example, does s/he have a corporation where all the proper taxes are withheld and reported? Does the consultant market his/her business to gain new clients? Does the consultant currently have other clients not related to your business?

• A guaranteed red flag for the IRS and other enforcement agencies is engaging a recently terminated or retired employee as an IC. This stands out on the IRS radar as a priority target. Enforcement agencies are likely to ask you “What is this consultant doing differently from when you reported him/her as an employee? How is the work different? How is the working relationship different? Why did you stop considering the consultant an employee? A previous employee can continue providing services for you after leaving; however, there are some safeguards you should employ. One of them may be to engage the worker through a third-party vendor, so that the tax reporting (either W-2 or 1099) is not by the previous employer.

This list obviously does not exhaust all the considerations when engaging ICs. To protect your company you need to stay abreast of the latest trends and changes in regulations and laws. Staying current is a full-time work — something best suited for the experts.

Disclaimer: Given the general nature and context of this article, the material presented should not be relied upon or construed as either tax or legal advice. For specific information on recent developments, the effects of particular factual situations or of a particular law in regards to your business, or before making decisions based upon this presentation, you should obtain the opinion of a qualified expert.