Independent Contractor Compliance Blog

Recently, I was asked to help a client to determine if a large number of part-time and seasonal workers could properly be treated as independent contractors (IC’s).  The client told me his HR people, procurement manager and project managers were always struggling with the issue and he knew they were making mistakes.  He was smart enough to know doing it right is more important than ever before because:

• The budgeting costs are significantly different between an employee-worker and an IC-worker.
• Tax agencies are becoming increasingly more aggressive about misclassified workers.
• If a government tax agency (IRS or state) later finds these workers were incorrectly classified as IC’s, the back taxes, penalties and interest are significant.

The cost of misclassification

For every dollar of misclassified wages the combined IRS and state tax assessments against the company can be an additional 52 cents plus interest, which is compounded daily from the original date the government decides you should have paid the money.

What to ask yourself

Here are a few of the questions needed to determine the true nature of the working relationship.  The whole process took the client just a few minutes, but probably saved many thousands of dollars (if not hundreds of thousands) and also provided some piece of mind.  These are not all of the questions, but it should give you some idea what is needed.

1. Are the services being provided by these workers a basic part of the company’s business, without which the company could not do its business?
2. Are the services also done by employees in the company (or had been done by employees in the company at one time)? 
3. Do the duties change from time-to-time, and may require direction, or instructions, to provide the new details of the work?
4. Are there specific procedures and policies the worker must adhere to (as opposed to just creating a finished product the best way the worker sees fit)?
5. Does someone in the company review the work and approve it?
6. Does the company provide the place to work and the equipment and tools needed to do the work?
7. Does the company pay for any expenses incurred (travel, supplies, etc.)?
8. Is the worker paid for the time worked, as opposed to fixed amount for a completed job regardless of the hours required to finish the job?
9. Would you consider it inappropriate for the worker to provide this service to other companies (like your competitors), and doing so could be grounds to terminate him/her?
10. Does the worker carry professional or liability insurance at his/her own cost?
11. Does the worker do anything to market his/her services as an independent business person to gain other clients?
12. Was the worker just looking for work and this project was offered?

There were a few other questions, and you’re right, the client answered YES to some and NO to others.  Some questions were weighted more heavily than others.  The answers were different for various services and individuals.  For a few of the professional workers it wasn’t clear at first and we needed some follow up for clarification.  That’s why it takes an expert to properly interpret the answers and reach the correct decision-employee or IC?

What was the outcome?

We concluded that over half the workers were legitimate IC’s, which is interestingly enough a little better than what the IRS believes are properly classified IC’s reported on 1099′s each year.

We set up the employee-workers on the payroll, with a full benefit package, for less than the client could provide the same benefits.  But maybe more importantly, the risk of misclassification was eliminated for these workers.

We set up the IC’s on an invoice payment system, administering the process for less than the client could do the same function.

Now the client doesn’t lose sleep worrying over worker classification

The client doesn’t need to worry about the IRS or EDD knocking on his door, or the workers running down to the unemployment office to file a claim, or about class action civil law suits for employee benefits.

He focuses on making the business work-not worker classification issues.