Independent Contractor Compliance Blog

This is the worst time to take shortcuts in your Contingent Worker and IC Consultant Compliance Programs.

Banks are being taken over by the government, Wall Street is being “bailed out” and the unemployment rate is higher than it has been in years. In this economic environment companies that can reduce costs have a better chance of surviving.

Cutting costs to stay competitive in today’s business world is mandatory for survival. One common method is reducing the cost of labor. This can mean not filling vacant positions and downsizing, but it can also mean using Independent Contractors instead of employees for your new projects.

The difference between the cost of an employee and an Independent Contractor can range from 10% to 25% or more. Independent contactors typically do not receive fringe benefits and companies don’t pay the usual government mandated taxes, insurances and other costs.

The savings of using an IC is seductive and real, unless you don’t protect yourself. A misclassified IC can cost you more than you would ever pay for an employee. Also, the risk of being selected for a tax audit during these times is far higher than during normal times.

Companies are taking risks just at the time the government is ramping up their audit programs.

This is the worst possible time for you to make a mistake in your IC compliance program. Why? Think about what happens during tough economic times:

1. Business volume drops.
2. Companies react by cutting costs.
3. Many times they do this by downsizing-letting people go.
4. When people become unemployed, and can’t immediately find work, they begin to look for income. They have food to buy, rent to pay and families to support.
5. It doesn’t matter if they were an IC or an employee, their survival instincts kick in and they go to the well to get a drink.
6. In this case they go to the Unemployment Insurance Benefit Well, which in California is administered by the Employment Development Department (EDD).
7. The problem is only ex-employees are entitled to UI Benefits.  Former IC’s are not.

State employment tax audit programs are funded, in part, by the number of unemployment claims filed.

This means as more people apply for UI benefits, the more money the EDD gets for the audit program. When the government hires more auditors they are going to do more audits, thus increasing your probability of being selected for an audit. So ironically, just as the private sector is hurting for money, the government is flush and has more resources to take private business money in the form of tax assessments.

Companies who have Ex-IC’s are more likely to be audited.

That’s right!  A major source of employment tax audit leads is a claim for unemployment insurance benefits by an ex-IC.  That’s because EDD will want to make your ex-IC, who files for unemployment, your ex-misclassified worker.  It’s what EDD does.  So it becomes very important to be sure you are properly classifying your IC’s and can prove it. Misclassified IC’s will attract auditors to your business.

You may think you are exempt because the IC signed an agreement that said he was not eligible for unemployment as an IC. Those agreements rarely work. Not only is there ample case law to defeat that agreement, but the consultant has now changed colors.

The IC who changed colors for unemployment benefits.

I’ve seen this happen thousands of times in my career. The same consultant who insisted on being an IC, now tells the EDD auditor he just needed a job and they were only hiring IC’s, so he agreed (It doesn’t matter if you have a different recollection-the government will believe them if they are credible). They tells the auditor they signed the contact because they were told to sign the contract or they wouldn’t work. That explanation is a surefire formula to make your former consultant a misclassified employee that will lead to a full-blown tax audit of your company.

How do you protect your company?

Your protection is to insure you have properly classified the IC’s when you engage them, and to properly document the project and relationship in the event you are challenged later. Typically, the challenge will come during difficult times, by a money flushed employment tax audit agency, who has a stake in finding that your IC is misclassified, qualifying them for benefits.

The burden of proof is on you and it is judging what happened in the past. Remember, many times the consultant is making a claim now and listing work he did one, two or three years ago to qualify. So you need to have the documentation that will prove you were right up to three years ago, after memories have faded, your project managers are gone, and the consultant does not work for you anymore.

Don’t cut corners on the IC Compliance Process, thinking you are cutting costs. Doing so could be very expensive.  If you don’t have the expertise in your company to protect yourself then call Collabrus.