Independent Contractor Compliance Blog

This question was asked at a recent Collabrus seminar in San Francisco by an HR person, not an expert on legal entities and IRS reporting requirements.

“It depends on how the LLC is organized and reports to the IRS,” I responded.

“I don’t understand-it’s an LLC. That’s how it’s organized,” she said.

I continued, “Maybe I should back up. LLC means Limited Liability Company. A common misconception is that LLC means Limited Liability Corporation. An LLC is not automatically a corporation.”

“Then how is it treated?” she asked.

“LLC’s can be organized as corporations, but also as sole proprietorships, partnerships or some other less common legal entities. Depending on how they are organized there are different requirements, so you treat an LLC based on how it is organized and files with the IRS.”

A different participant then asked, “How can I know that?”

“Have your consultants complete a W 9. The form requires the type of legal entity they are, their tax ID number, and other information you may need later,” I answered.

“So does a LLC organized as a corporation require a 1099?” a third participant asked.

“If the LLC is organized as a corporation it will most likely not require a 1099. I paused for a moment then added, “But there’s an exception.” (I got a few chuckles with that statement). “Let me explain…”

I clicked to a backup slide-not part of the regular presentation. The slide looks something like this:

I continued, “So if the LLC is organized as a sole proprietorship or a partnership, for example, then you need to issue a Form 1099-MISC. Corporations are generally exempt from receiving 1099′s. The exception is if you pay an attorney $600 or more for business related legal services, not personal legal services. So even if your business attorney is incorporated, you must file a Form 1099-MISC to report the payments.”

We then went on to a new topic: Events that will get you audited or investigated by the IRS and the State of California for worker misclassification…A very popular topic at Collabrus seminars, and the subject of a future blog article!

I hope you don’t hold it against me, but in a previous life I was a tax auditor for the government.

As a rank and file auditor I performed approximately 800 audits before becoming a supervisor, then a district administrator and on up the line…From that experience I can tell you firsthand that auditors look for the easy to find clues during the audit. They harvest the “low hanging fruit” by recognizing certain patterns typically found in businesses that misclassify their workers.

What are some of these patterns?*

• One of the early accounting tasks an auditor performs is to inspect the general disbursements journal or check register. The auditor is looking for regular, recurring payments to individuals with no DBA or corporate name. The longer the payments continue the lower the fruit becomes. If the payments are substantial and paid every two weeks for a long period of time, the auditor will suspect an exclusive relationship, pointing to the possibility the consultant has no other clients. This becomes the first “potentially misclassified employee” clue.
• The auditor also compares the names on the regular payroll to the names in general disbursements, contractor payments or other ledger accounts. Employees who receive payments as IC’s become another fruit to pick. Auditors find it difficult to believe your employee may also be your IC. It is possible for an employee to have a side business and perform work as your IC, but the auditor knows there’s a narrow range of tolerance for this scenario and most of the time your employee/consultant won’t qualify.
• The auditor discovers a consultant is doing substantially the same kind of work your employees perform. Many times the auditor learns the work is in the regular line of the company’s business-what your company does-another easy picking…
• The auditor looks in the disbursements journal or expense ledger and discovers these consultants are being reimbursed for expenses. Employees are reimbursed for expenses. Independent contractors pay their own expenses. A consultant who is reimbursed for expenses looks more like an employee. (At this point the auditor is asking more questions about these contractors and will probably talk directly to the consultants).
• The auditor may learn that you provide business cards, or other supplies, and that you provide the workspace, tools or equipment needed to perform the work. These are further examples typically associated with employees.

So during a brief inspection of your accounting records and a few conversations with you, and maybe a consultant or two, the auditor has harvested the following information:

• There are consultants performing the same or similar services as the employees
• The work is in line with your company’s regular business
• They work for an extended period of time, on a regular basis
• They work on an exclusive basis (most probably have no other clients)
• They do not have their own established business
• They are paid on a regular basis like employees are paid
• They are reimbursed for expenses
• They are provided with the supplies, tools and workspace to perform the work
• Some of them may be “admitted employees” who are also being paid as IC’s

At this point it’s only a matter of time before you receive a tax assessment in the mail.

This nightmare scenario can be avoided, if you protect yourself before the auditor knocks on your door.

The real protection comes from properly qualifying and documenting your consultants and projects prior to and during the life of the engagement. A small, upfront investment could save you many times that amount in the future.

*Remember, no single factor will decide the status of an individual. The total picture must be considered and each factor must be properly weighed in light of the profession and the project to determine if someone is appropriately classified as an employee or an independent contractor. It takes an experienced and knowledgeable professional to make defensible common law determinations on worker status. This is one of the valuable services that Collabrus provides to our corporate clients.

One of the most common misconceptions about worker classification that I encounter with clients is the belief that a written contract defining the relationship with a consultant as that of an independent contractor, responsible for his own taxes, will protect the company from misclassification challenges by either tax agencies, labor law disputes, or in civil matters.

Clients and consultants often argue that, “if you call yourself an Independent Contractor then that’s what you are and the government has no right to challenge that decision…”

Unfortunately, this is just not so.

A written contract is not the magic IC Bullet.

If a written contract defining the relationship as an independent contractor could not be challenged, there would never be any misclassified workers. Everyone could be an IC by signing a contract. This is obviously not the case.

The intent of the parties is only one factor.

How the parties define their relationship in a written contract is given minor weight in the final decision. The courts have consistently held that a written contract only shows the intent of the parties and does not determine the actual working relationship and status of a worker. 

In the now famous case of Vizcaino v. Microsoft, the 9^th Circuit Court of Appeals held that Microsoft’s temporary workers were common law employees despite the fact that they signed written contracts agreeing that they were independent contractors.

FedEx Ground had written IC agreements with its drivers, but California courts have consistently held their drivers are common law employees [Estrada v. FedEx Ground Package Sys. Inc., 64 Cal. Rptr. 3d 327 (2007)].

In Martin V. Phillips Petroleum, (1974, Cal. Appl decision) the court stated, “A contract cannot affect the true relationship of the parties to it, nor can it place an employee in a different position from that he actually held…”

As far back as 1917, courts were saying, “A contractual provision that a workman is an independent contractor is persuasive evidence of the intended relationship, but is not controlling and the legal relationship may be governed by the subsequent conduct of the parties.” (Brown V. Industrial Accident Commission, 1917, 174 Cal. 457)

The decisions go on and on-all acknowledging a written agreement exists then setting it aside to determine how the day-to-day relationship actually worked.

State and Federal Tax Auditors are trained that since the government did not sign the contract it is not binding on the government-law always takes precedence over a private contract.

Government auditors are trained that workers are often required to sign IC agreements before they can work for a principle, and that “If they wish to work they must sign the agreement…”

Government auditors are also told, “These are Adhesion Contracts….They are to be set aside and the actual facts of the day-to-day working relationship must be determined.”

Be sure your consultants and contractors are IC’s in more than just a title.

Don’t just bestow the IC title on part-time or temporary workers. A good IC contract sets out detailed provisions describing the IC working relationship. Be sure to follow the provisions in the contract.  

Most companies engage an attorney to set up a legitimate IC agreement, which clearly defines an IC relationship. However, it is common for the consultant and client company to sign the agreement and then forget about it. From that point forward the consultant is treated almost like any other employee in the company. The perfectly constructed IC agreement becomes almost worthless if it is not followed and unless the actual day-to-day working relationship supports a true independent contractor.

One more pitfall.

I’ve seen some contracts that do not cover all of the necessary common law elements. These contracts may not be sufficient to protect you even if you follow them to the letter. This is where someone who truly understands common law can help you: someone to set up the proper day-to-day working relationship, and document it so later you can prove you did it right.

Remember, it isn’t what you call it, but how it actually works that is important.

“A rose by any other name, still smells the same…”

(Shakespeare, please forgive me for misquoting you).

If your managers do not use and support your Independent Contractor (IC) qualification system, no matter how good it is, it won’t be effective, and your company will be at risk for misclassified workers.

Many project managers think it’s too much trouble to qualify a consultant-that it’ll slow the progress of the project and cost too much money.

If the project manager doesn’t support the qualification process he or she may think, “I’ll simply make an end run.” It is common for new clients to tell us, “We have a system to qualify contractors but our project managers think it is burdensome and slows down the implementation of the project, so typically they hire a consultant, negotiate the rate, the duration, the deliverables and all the other elements of the engagement before ever checking with HR or anyone else…by the time we learn about it the worker has already started and it’s too late to do anything about it.”

At that point the company hopes there is never a misclassification issue. The company is gambling at a high risk. The hiring manager has made a risk management decision that could put the company at great financial risk. This is totally the wrong way to engage consultants.

The Right Way…

In my public seminars, and when I help Collabrus clients, I show them a process that insures proper classification without creating a barrier to the project. Here is an outline of the process:

1. Establish the project (know what you intend to accomplish, the deliverables and time frames).
2. Estimate the budget (but don’t finalize it yet).
3. Select and qualify the consultant and project for IC or for employee. Yes, it’s not only the consultant who must qualify as an Independent Contractor, but how the project is run (working relationship) that is very important in determining a consultant’s status.
4. Finalize budget after the consultant qualifies as an IC or employee (IC’s and employees have different costs).
5. Insure documentation is preserved in a compliance file so that in the event of an audit you can prove you made the correct classification. This is very important since challenges almost always occur later, after the project is over, after the consultant is gone, and after memories have faded.

If you follow this plan, the work can start with no worry about misclassification in a very short time. Your managers soon discover that they can do it right and do it fast, so an IC qualification will not impede the implementation of a vital project or put your company at risk.

At Collabrus we have a proprietary process that mitigates your risk and is accurate, fast and easy. We have a commitment to give you the right answer, in writing, within one working day of receiving the necessary information to make the IC qualification.

Do you want to ensure protection against a misclassification challenge? In the eyes of an auditor, even if you made the proper call on the classification, if it isn’t properly documented it is open to interpretation.

One of the ways Collabrus protects you and your high-end consultants is our proven system of documentation for your projects and contractors. We begin this detailed, but easy and efficient, process before the consultant even begins working and continue it throughout the life of the project, including capturing the end-of-project environment for a final measure of protection. This rigorous proprietary process will help protect your company from the very real risks and costs of misclassifying your consultants.

Why is the “before, during and ending” documentation process so important?

• Challenges are almost always in the past. Typically when a government tax auditor knocks on your door, or you are challenged by a civil class-action suit, you might be required to prove today that you properly classified and utilized a worker several years ago. It is very difficult, and expensive, to reconstruct evidence retroactively.
• Memories fade. The level of detail required to prove you made the correct call on a worker misclassification case can be staggering. Reconstructing the proper evidence, at the necessary level of detail, two or three years after the fact is very difficult and sometimes impossible.
• Project sponsors and managers may be gone. If you are depending on the project manager to know everything, what are you going to do if he or she has moved on to another company and is not available?
• The contractor is not working for you any longer. Oftentimes, the contractor is not with you any longer, and sometimes he/she may be sitting on the other side of the table testifying against you-they might possibly the person bringing the action. In these cases, the ex-contractor is now hostile and oftentimes recalling a different reality than the one you remember. Who will the judge believe? It depends on credibility, but if both sides are equally credible, generally the courts rule on the “employee” side. So you must enhance your credibility with documentation that was created at the time the project was active and going well.
• The burden of proof is on your company to prove proper worker classification. The government only needs to assert you misclassified a worker and by law the burden of proof falls on you to prove you did it right.
• Finally, requiring documentation helps you properly qualify the consultant. Preparing the proper documentation also takes you through the proper qualification process. It reminds your managers they need to follow the rules and do it right. A good system is easy and efficient and insures you have made the right decision (and can prove it) before the work begins.

A misclassification challenge isn’t something you should wait to prepare for until after it happens.

Don’t be left standing (or sitting) alone with a tax auditor, or possibly a hostile attorney, who is asking what this project was about, and about the details of the day-to-day working relationship between your company and a former consultant from several years ago. Misclassification conflicts are too costly to depend on your memory and a dusty boilerplate IC contract as a defense.

WASHINGTON-The US Internal Revenue Service recently released statistics describing IRS activities from Oct. 1, 2009, to Sept. 30, 2010. The release includes information about returns filed, tax collections, enforcement and taxpayer assistance, as well as the IRS budget and workforce.

Some IRS statistics for FY 2009-10:

• Collected $2.3 trillion in revenue
• Processed 230 million returns
• Over 119 million individual income tax return filers received a tax refund, totaling $358 billion
• Audited/examined over than 1.5 million individual income tax returns
• Approximately 90,000 corporations, of all types, audited/examined
• Audited/examined approximately 30,000 employers for employment taxes
• Of those audited/examined for employment taxes, 3,714 apparently did not concur with the audit findings
• Out of all the employment tax business audits, 455 of them resulted in a refund for employment taxes totaling $43,492

How many IRS employees are there?

According to the report, the IRS began the fiscal year with a total of 92,577 employees.  It ended the year with 94,349 employees. Of these:

• 14,588 were Revenue Agents
• 5,922 were Revenue Officers
• 2,751 were Special Agents
• 1,610 were Attorneys

You could go blind trying to decipher this data as presented in the release; however, if you have the time you can browse through the IRS 2010 IRS Data Book for yourself to find more details.

What we should take away from this is the IRS is still alive and active, but there are more compliance hurdles than just the IRS…

In addition to the IRS, there are numerous other federal and state enforcement agencies looking over your shoulder, with their regulations and laws. For example:

• There is a 12-factor test that determines whether a worker is an employee or independent contractor under ERISA, for the purpose of the federal law governing employee benefits.
• The Equal Employment Opportunity Commission (EEOC) applies a test based on the “right to control the means and manner of worker’s performance” for federal employment discrimination law enforcement.
• The Fair Labor Standards Act (FLSA) applies an “economic realities” test including six factors to determine whether the worker is economically dependent on the business (and therefore an employee subject to FLSA) for wage and hour protections.
• The Immigration Reform and Control Act (IRCA) applies a 7-factor test to determine a worker’s immigration status.
• In addition, each state has its own unique set of employment security and labor laws to follow.

All these agencies employ experts who specialize in just their area of the law. Don’t rely on someone who has a bag full of other responsibilities to protect your company from them. You need a true expert, like Collabrus, on your side.

Whenever a consultant who doesn’t qualify for independent contractor status, is pushing back, arguing to be treated as an IC “or else,” I wonder if they have truly thought this through?

First, let me begin by stating that this does not apply to the consultants who have clearly established their own business, serve multiple clients and meet the qualification tests as an independent contractor. Those individuals are a valuable part of our economy and provide a critically needed service to other businesses.

I’m addressing those individuals who are just working under the radar, not meeting the federal or state tests of an IC and in all honesty are performing services as a misclassified employee. Oftentimes these individuals are the ones who dig their heels in when, after an expert review of the facts, are informed they do not qualify as an IC. They often make statements such as “I’ve always been an IC,” or “Either I work as an IC or I won’t work at all for you.”

A consultant who insists on being classified as an Independent Contractor when he does not meet the legal requirements puts both himself and the employer at great risk.

If you browse through this blog, or the Collabrus website, you will find dozens of articles that describe the dangers to the principle company if a consultant is found to be a misclassified employee. They include:

• Being assessed for the employer’s and the employee’s share of all payroll taxes, plus penalties and interest.
• All consultants performing services for the company are reviewed for misclassification.
• Agencies share information so there will be others standing in line once they realize there are misclassified workers.
• The company may be exposed to subsequent class action law suits.
• There are substantial legal fees associated with these actions.
• Management’s focus is re-directed from their customary work-a hidden cost.
• The company is typically placed on a “watch list” for years after, where any minor mistake is caught and billed…

However, the consultant is also exposed to risks:

• The IRS could disallow the business expenses claimed on a Schedule C for past years, creating a retroactive tax liability with penalty and interest.
• The IRS conducts “Retirement Plan Audits.” If the consultant has a self employed plan the IRS could decide to audit it, leading it to being disallowed.

Possibly more important are the unnecessary costs a misclassified consultant, who is pushing to be treated as an IC, faces:

• As an employee, your employer is responsible for withholding income taxes from your paycheck. As an IC you must manage and pay your own withholding at least once per quarter. Don’t fall behind-the IRS is brutal…
• As an IC you are responsible to pay both shares of Social Security and Medicare taxes. These total over 15%. Employers pay half for their employees.
• Some states charge a tax on professional services. For example, the states of Delaware, Hawaii, New Mexico and South Dakota impose a tax on accounting services. There are others. Massachusetts and Florida’s tried it and were forced to repeal them because of its unpopularity and its significant administrative problems. However, as governments look for more revenue watch for this to grow in popularity.
• As an IC you are exposed to personal liability if something goes wrong. As an employee you are protected under the employer’s umbrella.
• To protect yourself you may buy Professional Liability and Errors and Omissions Liability Insurance. IC’s pay for it, employees don’t.
• Maintaining a valid business establishment is another concern for IC’s. You may need to incorporate, file articles of incorporation with your state, appoint officers, a board of directors, bylaws, hold formal meetings, document the meetings, pay annual fees, market your services to gain new clients, maintain a business location, file a host of business and tax reports to various jurisdictions and a host of other tasks to keep your business valid and in good standing. As an employee you just show up and do your work.
• Health benefits? Many companies offer health insurance to their employers. Independent contractors pay their own way.
• How’s your 401(k) doing? Many employers provide matching contributions, up to some level, for employees, which can really leverage your retirement fund. IC’s are on their own.
• Company Stock Options are a great avenue to personal wealth and to enhance your retirement options. Many companies offer them to employees but not to independent contractors.
• Loyalty? Companies tend to support their employees, but often see contract labor as a come-in-do-the-job-and-leave asset. IC’s are often the first to go in hard times.
• Longevity and stability? An IC must put their flesh on the market every few months to seek out new clients. Employees show up and do their work.
• IRS Audits: The IRS scrutinizes 1099 and Schedule C Filers much closer than their W 2 counterparts at the same income level. Why? Because the IRS estimates 58% of the 1099 Schedule C Filers underreport their income and/or take erroneous, or excessive, business expense deductions.

If you are a consultant who is being told you do not qualify as an IC and must be placed on the payroll, consider the potential negative repercussions of misclassification and recognize that in this situation you may be better off as an employee.

Each year, for the past several years, both houses of Congress have introduced bills to really toughen up on worker misclassification. Each year the bills have quietly died in committee because of higher priority issues, such as: elections, stimulus, health care reform, wars, deficits, etc. Here comes a new legislative season and another run on worker misclassification-another opportunity for law makers to “Level the Playing Field.”

Senate Bill 770

On April 8, 2011, Senators Sherrod Brown (D-Ohio), Tom Harkin (D-Iowa), and Richard Blumenthal (D-Conn.) introduced Senate Bill 770, titled the Payroll Fraud Prevention Act. This bill is basically a remake of last year’s Employee Misclassification Prevention Act and copies several years’ of similar proposed legislation that keeps being introduced year-after-year. However, this new bill is more aggressive than its predecessors because it characterizes worker misclassification as “Payroll Fraud.”

Senator Brown says, businesses that misclassify workers are cheating workers…and other businesses that play by the rules.

One of the co-sponsors, Senator Brown (D-Ohio) issued a press release characterizing companies that misclassify workers as “cheating workers…and other businesses that play by the rules.” He also referenced the “tax gap” stating the bill will “relieve the burden on American taxpayers who foot the bill when businesses [misclassify their workers].”

The bill addresses unemployment insurance tax, federal minimum wage, overtime, child labor laws and sets up a mechanism for IRS audits.

S 770, if passed into law, would expand the federal Fair Labor Standards Act (FLSA), giving the Department of Labor (DOL) much stronger tools in discovering and punishing employers who misclassify their workers as ICs. The bill would also require DOL to report non-compliant businesses to the IRS.

(Typically when the IRS audits a company for worker misclassification they also look at the company’s income and expense items).

A repeating requirement, seen in almost every version of this bill for the past several years is the required notice to all workers-employee or IC-with harsh fines.

The proposed law would require every business to provide a written notice to all workers (including currently employed workers). This notice would notify them if they have been classified as an employee or “non-employee.” The notice would advise “non-employees” they do not have the same rights to benefits as employees. The notice would provide a phone number and website to contact DOL to make further inquires or to file complaints (i.e. instructions on how to ask DOL to set up an audit of the business!)

This bill creates a legal presumption that a “non-employee” is an “employee” if the business fails to provide the worker with the notice at the time the “non-employee” begins providing services. This presumption significantly raises the bar on proving you did it right.

It also makes it a criminal offense for discharging anyone (employee or non-employee) who:

• Makes an inquiry to DOL,
• Initiates a “proceeding” outlined in the notice,

The fines for the above, or for any employer who fails to provide the prescribed notice, is between $1,100 and $5,000 per worker. This fine would be in addition to all other civil suits, fines, taxes, penalties and interest that may arise from the misclassification.

Some other provisions of this bill are:

• Directs DOL to conduct “targeted audits” of certain industries “with frequent incidence of misclassifying employees as non-employees.”
• Creates a new definition of workers called “non-employees,” and defines this classification as a “Covered Individual,” even if, “the non-employees” are properly classified as independent contractors.
• Identifies individuals with their own corporation as “non-employees” who are covered by this bill. “Including those who provide services through a corporation or LLC, if they are required to create or maintain such entities as a condition for the provision of such labor or services.”
• Adds a new provision creating a “special prohibited act” under federal law if you “wrongfully classify an employee as a non-employee.”
• Provides for triple damages for willful violation of the minimum wage or overtime laws where the employer has misclassified the employee.

Click here (S. 770), if you would like to read the Payroll Fraud Prevention Act for yourself.

If the bill passes you may expect President Obama to sign it into law.  When he was a U.S. Senator he introduced a similar bill along with fellow Senators Kennedy and Durbin.  That bill was entitled, “Senate Bill 2044, the Independent Contractor Proper Classification Act of 2007.’

President Obama is expected to sign a bill repealing the law requiring all businesses to file 1099 forms with the IRS for payments to any business totaling $600 or more for goods or services, including payments to corporations. The provision had been part of healthcare reform law, known as the Patient Protection and Affordable Care Act 2010.  It was scheduled to be effective in 2012.

Both Houses passed the repeal

Last week the Senate approved the repeal by a vote of 87-12 HR 4. The repeal had already been passed by the House. The 1099 requirement was only one paragraph of the 2,000 plus page health care law, but it was estimated compliance would have cost American businesses untold millions. The provision had been criticized by business groups from both sides of the political spectrum.

It seemed the repeal had been assured for several months

In his State of the Union address on January 25^th, President Obama addressed his healthcare legislation, saying he was open to making adjustments. Referring to the 1099 requirement for corporations he said, “We can start right now by correcting a flaw in the legislation that has placed an unnecessary bookkeeping burden on small businesses.”

The Small Business Paperwork Mandate Elimination Act of 2011, reads in part:

Section 9006 of the Patient Protection and Affordable Care Act, and the amendments made thereby, are hereby repealed; and the Internal Revenue Code of 1986 shall be applied as if such section, and amendments, had never been enacted.

NOTE: This does not eliminate the Form 1099

The Form 1099 is still required to report payments such as these:

• To Independent Contractors who earn more than $600
• To an attorney who is not your employee (even if they are incorporated)
• To an individual / sole proprietor
• To a partnership
• To an estate

The IRS is most likely not happy with the repeal

The IRS had been lobbying for years for 1099 reporting of payments made to corporations. They had been telling Congress adding 1099 reporting for payments to corporations would help to close the Tax Gap which is estimated at $345 billion per year. The provision would have allowed the IRS to more easily track billions of dollars in corporate income.

The Congressional Budget Office had estimated that the provision would have raised $22 billion in additional revenue, helping to close the Tax Gap and help fund the new health care law.

Other tax provisions of the Patient Protection and Affordable Care Act 2010 that may, or may not, yet be addressed (shown in order of projected effective date):

• Year 2013: Increases the Medicare payroll tax and expands it to dividend, interest and other unearned income for singles earning more than $200,000 and joint filers making more than $250,000.
• Year 2014: Provides a tax credit subsidy for families earning up to 400 percent of the poverty level, currently about $88,000 a year, to purchase health insurance.
• Year 2014: Requires most employers to provide coverage or face penalties.
• Year 2014: Requires most people to obtain coverage or face penalties.
• Year 2018: Imposes a 40 percent excise tax on high-end health insurance policies.

The White House press secretary released a statement on Tuesday following the Senate vote that read in part: “…as we move forward, we look forward to improving the tax credit policy in this legislation to ensure we protect small businesses and middle-class families.”

The President is expected to sign HR 4 into law.

Have you properly classified your consultants and can you prove you did it right? Are you taking the proper precautions to insure your independent contractors are really IC’s? Do you have an expert on staff, or will someone from your HR or Finance team be assigned with the unpleasant task of fighting the professionals who will be challenging the status of your consultants?

In my thirty-plus years of experience, I have found that most businesses think they are protected but fall way short of what’s required when faced with a real misclassification challenge (class action law suits, workman’s comp claims, federal or state tax audits, third party tort actions, etc). When one of these events occurs they are shocked at the level of detail and substantiation needed to prevail.

The time to prepare is when you are first engaging a consultant.

Both the project and the consultant must qualify as an Independent Contractor. Here are a few things to consider.

Did you properly set up the project to support IC status?

Some characteristics of a project that would help support an IC classification:

• The contractor is paid for a completed job, not for his time.
• He can set own hours.
• He provides his own supplies and equipment.
• He uses his own judgment as to where and how the work is best performed
• The day-to-day duties and tasks are not controlled by the principle
• The deliverables are clearly spelled out in the contract and cannot change without renegotiating the contract or statement of work (SOW).
• He does not attend regular meetings along with the client company’s employees.
• The work being performed isn’t the same as regular employees in the company.
• No progress or time reports about his work are required.
• He isn’t working year-after-year, exclusively for the principle, with no other clients.

Is the contractor truly set up in an independent business of his own?

Here are some traits of a contractor who has established his own independent business:

• The contractor may have assistants at his own expense, to help complete the work.
• The contractor may work for other companies, even competitors, while completing your project.
• The contractor actively markets his services to gain new clients.
• He has other clients.
• He has a corporation, or has formed another type of business entity, with a dba and other indicators (business cards, stationary, etc) that he is operating an established, independent business.
• He has an office or work location for his business.

Why do most companies efforts fall short?

Even though properly qualifying and documenting the relationship can be done economically and efficiently, I have found that many businesses do not assign enough importance to the process. The task is often assigned to the project manager or the HR manager. These managers typically do not have the in-depth knowledge and experience, or the time, to perform and document the qualification process. They often see it as something to just get out-of-the-way so they can do their real work.

When the conflict comes, your company will be facing an expert who has the experience, knowledge, time and attention to detail.

When there is a challenge two or three years later the opposing party will be challenging you to recreate the circumstances and facts from the past. Most companies are not able to construct a convincing case and are forced to settle. They pay up, lick their wounds, and swear not to get caught that way again. They pay a very expensive tuition for the education-much more than they would have paid doing it right in the beginning.

Collabrus is a leader in the contingent workforce management and IC compliance.

Our compliance staff are experts in making the proper employee-independent contractor status determinations in every conceivable industry, on both sides of the tracks, and have performed literally thousands of qualifications. This is the level of expertise you should seek out to qualify and document your consultants.  Why? Because the other side will employ such experts to prove you wrong when the conflict comes-you can bet on it!