Independent Contractor Compliance Blog

The Competitive Value of Contingent Workers and Independent Contractors

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. 

Common Misclassification Traps

At one time or another, almost every business has engaged a consultant who insists on being an independent contractor (IC) when s/he really doesn’t meet the qualification test. Often the consultant insists the only way s/he will work is as an IC. Everyone does what they believe is necessary to get the job done. In most cases, it turns out well.

However, sometimes companies come to regret this decision. The real danger can hit two or three years after the project is over. Here is a very common scenario:

- The consultant, who once insisted on being an IC, is now applying for unemployment benefits. The consultant learns that only ex-employees (not ex-ICs) are entitled to unemployment benefits, and the consultant’s perception of the project begins to change.

- The consultant contacts the unemployment office and a sympathetic caseworker wants to help the former consultant receive benefits. The issue is referred to a state employment tax audit office to verify the status. In the meantime, the former consultant may be paid benefits on the assumption s/he was misclassified.

- When the state tax auditor receives the assignment, an information gathering process begins:

  1. Verifying the correct IC status of the former consultant
  2. Arranging a tax audit to review all potential misclassified workers in the company — not simply the consultant who filed a claim

The result is that companies may need to prove that every IC engaged during the statutory period (normally three years) was properly classified. This common scenario accounts for tax audits on thousands of businesses each year.

Other facts to consider are:

  • The consultant applying for unemployment benefits is no longer loyal to the company, because he needs benefits and his perspective has most likely changed.
  • The manager may have moved on and is not available to provide details about the working relationship.
  • Even if there are still people who remember the details of the project, their memories have faded — details are lost about the day-to-day working relationship.
  • The auditor will give the former consultant’s version of the working relationship more weight than the company’s, unless the company has some very convincing evidence.
  • Companies’ primary evidence is typically a written contract predicting what was going to happen in the future, while the auditor is looking at what actually happened in the past. In addition, written contracts rarely provide the level of detail required to resolve a classification issue.
  • Statistically, more than 70% of employment tax audits result in a finding of misclassified workers. One reason for this high rate is that the burden of proof is on the business to prove it acted correctly, not on the government to prove its tax assessment is correct.

Misclassification challenges can also result from other incidents. For example:

  • A consultant is injured on the job
  • A consultant alleges unjust treatment
  • The consultant claims entitlement to employee fringe benefits

In any of these cases, the consultant may be telling the tax auditor, attorney or the judge that the project was accepted as an IC because it was the only way to get work. Enforcement agencies refer to this as an adhesion contract and use it as evidence there was direction/control from the employer’s side. Usually, they find that the consultant was a misclassified employee.

The best way to prove the IC was properly classified is to have an expert qualify the consultant and then secure and maintain the proper documentation from the project’s inception.

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

Cures for Common Misclassification Mistakes

I recently read an article that cited a survey of more than 1,400 CFOs from U.S. companies that have twenty or more employees on staff. These 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.  

Reporting Independent Contractors to the Government

A common mistake many companies make is failing to report independent contractors (ICs) to the Employment Development Department (EDD) right after starting an engagement. In California, for example, the payer must report the IC to the EDD within 20 days of paying, or contracting to pay, $600 or more for personal services.

Since you must report the IC for anticipating paying him/her $600 or more, it is possible the report is due before the first payment is even made to the IC. This is a nationwide requirement and the information is posted to a national database designed to locate parents who are delinquent in their child support obligations.

The IC reporting requirements apply to any business, or government entity, that hires any individual consultant, contractor or other IC.  If you have contracted with a corporation, a general partnership, a limited liability partnership (LLP), or a limited liability company (LLC), this requirement does not apply.

Each state has developed a process to meet this national requirement. The State of California EDD form is called a “Report of Independent Contractor(s) DE 542.”  However, in California, you may file electronically or create your own form as long as it provides the proper information.

The law requires the following information:

For Businesses:
o Business name
o Federal employer identification (EIN) number and/or your first name, middle initial, and last name
o California employer account number (if applicable)
o Address and telephone number

For ICs:
o First name, middle initial and last name
o Social security number
o Address
o Start date of contract (if no contract, date the payments will equal $600 or more)
o Total amount of contract, including cents (if applicable)
o Contract expiration date or state that it is an ongoing contract

California’s EDD can assess a penalty of $24 for each IC not reported within the required timeframes.  Also, a penalty of $490 may be assessed for each IC not reported. These penalties are typically assessed as an add-on during an audit or other inquiry by the EDD.

This is just one of many legal requirements concerning the contingent workforce.  Knowing about these requirements is routine business for compliance experts. It is just another reason to ask them for help when engaging a consultant or IC for your special projects.

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.

Best Practices When Engaging Independent Contractors

Our clients often ask for a few general tips when engaging their independent contractors (ICs). With this in mind, here are five essential steps to getting this done correctly:

First, you should have a written agreement that defines a specific deliverable and defines the end of the project. The deliverables should be measureable, ideally with dates for completion and metrics to determine if the project was successful.  The agreement should leave the means and methods to achieve those deliverables to the contractor.

Second, do not supervise the contractor. You probably engaged the contractor because s/he is an expert with abilities you did not have within your business, so leave the contractor alone to do the job the best way s/he sees fit. You should only be concerned with the final product you agreed to, at the price you agreed to, and within the time frame you agreed to. How the contractor gets there is his/her concern.

Third, you are safer if you engage a contractor who already has an established business. Ideally, the contractor should have a corporation and is an employee of that corporation. If so, you should contract with the contractor’s corporation to complete the project, not the individual. All payments should also be made to the corporation. Let the corporation pay and properly report any taxes due on wages and such. Also, you want your IC to have other clients that are not connected to your business. Your IC should be actively marketing to win new clients. You do not want the consultant to be financially dependent on you.

Next, when the job is completed, as agreed in the contract, you have to end the working relationship. Do not fall into the trap of using a contractor for a series of jobs that go on and on because it can lead to a misclassification. If you really want to keep this individual for a long term project, you should consider better ways to do it.

Finally, don’t fall for the “same work different title” trap.  Many businesses act on bad advice and convert their former employees to ICs by simply changing titles to “independent contractor” and telling the workers they must pay their own expenses and taxes, when in reality nothing substantial has changed in the working relationship. Many civil suits, and even more tax audits, are spawned this way.

To navigate successfully through the worker classification jungle you need an expert to guide you. For hiring managers, the rule of thumb is to be proactive in protecting their companies when engaging contingent workers — both employees and ICs.

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.

 

Is Your Company At Risk With Your Independent Contractors?

Here’s a fast quiz you can take to get an idea of the level of risk your company is exposed to for being audited, or other misclassification challenges such as a civil lawsuit when hiring independent contractors (ICs).  Awareness of your exposure is the first step to protecting yourself.

Answer yes or no to the following questions:

1.  Do you classify consultants and temporary workers as ICs because it’s company policy to make all temporary workers an IC?
2.  Have you ever said to a job applicant, “We aren’t hiring employees, but we have an opening for an independent contractor?”
3.  Is it possible any of your former ICs will file for unemployment insurance benefits?
4.   Is it possible one of your ICs can become injured while working (car accident, carpel tunnel, stress, or slip on the floor in the break room)?
5.   Do you have ICs or “consultants” who have been working on a series of projects; job-after-job, year-after-year, but are not on the payroll?
6.  Do your IC consultants report to a manager in your company on a day-to-day basis?
7.  Do any of your ICs supervise your employees?
8.   Do you have ICs who work exclusively for you and have become dependent on you for their sole source of income?
9.  Do your ICs routinely attend regular employee meetings?
10.  Do you expect your ICs to work full time for you?
11.   Have you issued a Form 1099 and a Form W2 to the same individual in the same tax year?
12.  Do you have ICs working side-by-side with regular employees, doing similar duties, under the similar conditions?
13.  Do you believe you can adequately protect your company against misclassifications without engaging an expert?

If you have more than eight “yes” answers, you definitely have a high risk of getting in trouble if you are being audited. Actually, answering yes to any of these questions means your company is exposed to some risk.

Most businesses do not have a reliable system in place to insure they are properly classifying and handling their contingent workers and ICs. Therefore, when they are challenged they are not prepared or protected. It is too late to prepare after you have been sued or an audit begins. The perfect time to prepare is before the challenge arises.

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.

LLC: Company vs. Corporation

If you wonder what LLC stands for, here is your answer: It means “Limited Liability Company”, not “Limited Liability Corporation.”  Assuming an LLC is automatically a corporation is a mistake many make. In reality, all LLCs are not corporations and are not automatically an independent contractor (IC) either.

An LLC can be organized as almost any type of business structure:

• As a sole proprietorship
• As a partnership
• As a corporation
• Or, as a few other less common forms of business entity

LLCs are treated depending on how they are organized, or more accurately how they have elected to be taxed by the IRS. The owner of the LLC may make a selection of how the business will be taxed for federal income taxes. If the owner wishes to have the LLC treated as a corporation, he or she must file a Form 8832 with the IRS requesting to be treated as a corporation for federal tax purposes. When the election is approved by the IRS, the LLC can be treated as a corporation for both federal and state purposes.

If the owner of the LLC neglects to apply to the IRS to be taxed as a corporation then the LLC will most likely be considered a sole proprietorship, or in less common instances a partnership. What difference does it make? Sole proprietorships and partnerships must receive a Form 1099 at the end of the year (assuming they are paid over $600 by your business). On the other hand, LLCs that are taxed as corporations don’t receive a Form 1099 for their services. Also, it is much easier to prove a corporation is an IC than it is for a sole proprietor.

There is one exception to the 1099 rule. If the LLC corporation is an attorney, then a 1099 is still required. Attorneys are a special circumstance specifically identified as requiring a Form 1099 when performing legal services for business clients — even attorneys with corporations.

How do you know if your consultant has a corporation?

• You could ask for a current copy of the Certificate of Incorporation, showing the corporation is properly registered and all fees are current.
• Ask the consultant to provide you with a copy of his last corporate income tax return.
• Ask to see the approved letter from the IRS, indicating the LLC will be treated as a corporation for tax purposes.
• Ask to see the payroll tax returns showing that the payroll taxes have been properly handled for the corporate officers.

However, there are other ways to handle this type of cases. Verification of the entity is an area best left for experts and it’s just one of the basic services that managed services providers offer to their clients.

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.  

Are You and Your Consultants Pursuing The American Dream?

The American Dream is founded on the belief that an individual can build a business with determination and hard work, starting with nothing except an idea or a skill.

Being your own boss — an independent contractor — is at the heart of this dream. Successful independent contractors eventually grow their small business into a larger company employing others, creating jobs and securing a good life for those who also believe in hard work and determination.

This principle is the very foundation of what makes America great. However, the road to achieving The American Dream has a few potholes:

The IRS targets tax returns of self-employed individuals for audits.

According to the IRS, last year more than 41 million individuals filed tax returns as self-employed individuals. Collectively, these independent contractors reported more than one trillion dollars in gross income.

The IRS acknowledges they look for taxpayers who file a Schedule C – and self-employed individuals almost always file a Schedule C.  A review can range from a single item mail inquiry to a full-blown income tax audit.

The IRS cites two major justifications for targeting Schedule C filings.

Exaggerated business expenses claimed by many IC’s:

The IRS states that claimed expenses are often significantly overstated and therefore become a source for additional tax assessments during an audit.
Common examples include:

  • Home office space not used exclusively for business
  • Vehicle mileage for personal use
  • Subcontractor expenses
  • Travel, meals, and entertainment expenses
  • Line 27 “Other Expenses”

Potentially misclassified workers

If the IRS determines that the self-employed individual did not qualify for independent contractor status and should have been classified as an employee, the individual will not be authorized to claim expenses on a Schedule C.  These expenses will be disallowed as will any contributions the individual made to a pre-tax retirement plan they may have established.

If the individual gets audited, so could the companies for which they worked.

The IRS may also use a disqualification of an independent contractor status for an individual as a backdoor audit lead into your company. If the IRS finds that a misclassified worker provided services exclusively for a single company, oftentimes the IRS will audit that company. The greater the estimated revenue an audit could produce, the greater the possibility the company will be audited.

Companies that utilize large numbers of independent consultants are at a higher risk of being selected for a “backdoor audit.” Once the IRS selects a company for this audit, the inquiry may extend to any source the auditor believes could produce additional revenue.  In other words, the audit may not be limited to just payroll taxes.

In the end, both a company and the individual are exposed to an increased audit risk when the worker files a Schedule C. This is just one of many triggers for an IRS audit for not only an individual but for an entire company. And, in most cases, an IRS audit will prompt a state audit as well.

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.

Engaging Independent Contractors In Your Company

With politicians clamoring for more revenue, it doesn’t take a tax expert to know enforcement is on the rise, and many legislators see worker misclassification as a potential goldmine of additional revenues.

They push for stronger independent contractor (IC) enforcement because, while collecting more money, they can say they are just trying to “make it fair” for all workers and businesses by “leveling the playing field.” This is why both the state and federal governments have greatly increased funding for worker classification enforcement in recent years. 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 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.

 

How to Deal With Employee Misclassifications

If you are reviewing a consultant’s file and suddenly realize that you have a misclassified independent contractor (IC), you must address the issue right away. If you’re thinking: “I will ignore it…it’ll go away when the project ends”, the consequences of your decision can cause trouble. The longer the misclassification goes uncorrected, the more likely a bigger problem will result – such as civil suits, labor law violations and problems with tax enforcement agencies.

Many times, one of these events will come back to haunt you. In addition, enforcement agencies often examine the status of all of your consultants once they look at one. It’s smart to deal with the misclassification before it grows into a bigger problem that could cost tens of thousands of dollars, consume time needed to run the business, and potentially damage your company’s reputation.

There are two valid approaches to correct the problem:

1. Convert the consultant to an employee, or
2. Restructure the job and the working relationship to qualify as an IC

When choosing either of these approaches in-house, you should objectively assess if you have the ability, knowledge and experience to do it right. Will you be subject to internal pressures because managers don’t want to give up control over the day-to-day working relationship? Or does it matter if they don’t control all the details of how the project gets done as long as they get the same end result?

Sometimes changing a few key factors in the working relationship will do the trick. However, it’s not always easy to know which factors are important and which don’t make a difference. There is no universal formula and the answer can change from profession-to-profession.

That’s why managing risk mitigation is something best left to the experts.  Spending a small amount now to engage a high-end contingent workforce management company may save many times that amount later.

A quality contingent workforce company like Collabrus will provide much more than risk management, such as:

1. Program Management Services — hiring and on-boarding administrative processes, contract management and monitoring, employee and IC contractor support, project oversight, and budget control.

2. Pay and Benefit Services — benefits programs for contingent employees and optional programs for ICs, consolidated online invoicing and billing system for time, deliverables, expenses and other payments, employee withholding and reporting, 401(k) and insurance benefits.

3. And, of course, IC validation (including oversight of other vendors and payroll services you may use), online contract tracking and reporting, documentation and end of engagement processing.

We can help you correct problems and assist in the change management so the transition goes smoothly. This allows your ICs and temporary employees to provide their services in the most beneficial and economical way and yet minimize your risk exposure to civil liabilities, tax liabilities, employee benefits disputes and labor law violations.

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.

 

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