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 independent contractor (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.