Independent Contractor Compliance Blog

It’s not uncommon for fast growing companies to subscribe to the philosophy of avoiding costs today to maximize profits, thinking they can pay them much later, if ever. When you apply this concept to Independent Contractor compliance it sometimes goes like this: “We’ll save money by making our workforce IC’s and take our chances. We’ll invest the money saved now and only pay up if we’re ever assessed for being wrong. Even if that occurs, we’ll still be ahead, because a $1 invested today will be worth $1.25 (?) in three years. We can pocket the .25 cents, coming out ahead.

The problem with this concept is the cost in three years is much more than you’d expect.

Don’t forget that government agencies share information today.

First, it isn’t just the one agency that knocks on your door. Today, government tax and labor law enforcement agencies have Memorandums of Understanding (MOUs) with each other. These contracts allow the agencies to share information both ways and sometimes they even come to audit you hand-in-hand. This means when one enforcement agency finds misclassified workers they share the information with others who then add their tax assessments and fines. The combined liabilities have been known to close businesses down.

For example: The IRS and the Department of Labor share information. The California’s Employment Development Department (EDD) and California’s Department of Industrial Relations (DIR) share information.  The IRS and EDD share information. The IRS and EDD share with the Franchise Tax Board (FTB). Both EDD and FTB share with the Board of Equalization (BOE). The list goes on and on.

The point is when one agency finds you they tell the others…

In dollars:

If your gross payments to your “misclassified workers” were $100,000, just the EDD and IRS assessments can be $53,000, plus interest (see below). I didn’t include fraud penalties, which hopefully will never apply to your company.

Why so high?

Both state and federal law provides that if an employer fails to withhold income tax from an employee’s wages when the wages were paid then the employer becomes liable for those taxes. Also, don’t forget Social Security Tax, Medicare and Unemployment Insurance Tax. So you could be assessed all of these-both the employer’s and the worker’s share.

What about the income tax abatement process?

True, there are abatement processes, using various procedures including signed affidavits, but in my experience over 50% of the assessed income and other withholding taxes never get abated, meaning the employer must pay them. Why?

The reasons vary, but some examples, in my experience, are:

• The consultant is no longer cooperative (sour grapes…)
• The consultant can’t be located
• The consultant won’t sign the affidavit (maybe he didn’t pay his taxes?)
• When you ask the tax agency to look in their records to verify the individual paid his/her own taxes the response often comes back “Can Not Verify.”

(Why?  Remember, tax agencies are revenue generators. They aren’t going to spend a lot of resources helping you not pay taxes)

Don’t forget the penalties and the interest is compounded daily.

There are more penalties than we want to list here, but they start at 10% and go to 100%. Penalties can be cumulative, meaning you can be charged with several at the same time.

The current government interest rate charged is between 7% and 9%, compounded daily from the original date the auditor determines you should have paid.

I’ve seen the interest alone double the amount of money owed.

Hidden costs:

You should also consider:

-Legal fees-It takes many billing hours to defend these cases.

-Management’s time being expended to fight the audit or “circle the wagons.”  This takes time away from their business of running the company.

-The potential harm to the company’s reputation.

• Clients
• Investors
• Attracting the best available talent
• Credit ratings (tax agencies file tax liens)

The domino effect…

You’ve all heard about Microsoft’s labor problem in the 90′s. It eventually cost them an estimated $90-$100 million-not counting legal fees or opportunity costs from lost management’s time.

But did you read about the FED EX public announcement (November 2007-effective January 2008) that they are changing their business model in California because the numerous challenges to their Independent Contractor business model?  They have lost in every court level-including federal appeals court. They publically state the administrative costs alone will cost them approximately $40 million the first year to make the changeover. The union and other inside sources say that number is actually closer to $100 million.

It’s not that difficult or expensive to do it right in the beginning.

Is this a risk and cost your company really wants? The cost and effort to make the right decision about your contingent workers and IC’s now is substantially less than being found wrong later…and it isn’t difficult if you utilize an expert.