Question of the Week: If our Consultant Truly Starts out as an Independent Contractor and Then Slowly Evolves to an Employee as Time Goes on—What Should we do?
Actually this happens quite often.
I can think of four options.
- Continue employing the misclassified worker until you are caught up in a misclassification action such as an employment tax audit, workman’s comp claim, or civil lawsuit.
- Terminate the relationship as soon as possible.
- Legitimately change the relationship back to an Independent Contractor now.
- Begin reporting the worker as an employee retroactive to the beginning of the calendar year. That way there is instant protection for you and the consultant, and a W-2 is issued for the entire year.
Let’s look at the options one at a time.
Option 1. Continue employing the misclassified worker until you are caught up in a misclassification action such as an employment tax audit, workman’s comp claim, or civil lawsuit.
There’s really not much to say about this option. It’s the Ostrich Head in the Sand System of Compliance. You may be following this course right now, but I don’t recommend it.
Option 2. Terminate the relationship as soon as possible.
The statute of limitations are variable depending on the circumstances and the actual action that will hit you; however, the sooner you stop the practice the sooner the statue begins to run out and the sooner you can see the light at the end of the tunnel.
The down side is obvious-you lose a valuable consultant and they may file for a wrongful termination suit against you-sour grapes-what you were trying to avoid…
Option 3. Legitimately change the relationship back to an IC now.
If you recognized the relationship drifted, then put it back. It’s pretty straight forward.
The downside is this is sometimes easier said than done. Maybe the consultant has become an integral part of your company the way services are now provided and you don’t want to give up the control you have over them.
Option 4. Begin reporting the worker as an employee retroactive to the beginning of the calendar year, so there is instant protection for you and the consultant, and a W-2 is issued for the entire year.
You probably can tell, I consider this the safest, and best, of the options. As of that moment, assuming no actions have already been taken against your company, your risk begins to decline steeply. In three years or so, your exposure for the tax, or civil suits, completely goes away and you still have your valuable employee.
The downside is the slightly higher cost of employee benefits and employer taxes, over an IC without those costs. Also some consultants will resist this change because they have a sweet deal with the stability of an employee and the tax breaks of an IC. This is one reason the IRS considers misclassified 1099’s a significant contributor to the Federal Tax Gap. It’s what will put you in jeopardy of an audit.
Not taking action because of “push back” by the consultant is analogist to saying, My car is speeding out of control towards a 1000 feet cliff, and in danger of going over, but I don’t want to stop because it may put wear on my brake pads.
Warning: Do something now! Don’t wait! Take positive action to change before you are caught in a misclassification action.
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