Independent Contractor vs. Employee - A Minefield for Employers
The hot independent contractor vs. employer debate has not cooled off in the last 20 years, but the way worker classification standards has. If you are a business that uses independent contractors, beware that you often have conflicting guidelines at the state, federal, and local levels.
Independent Contractors in the Early 1990s
During the early to mid-1990s the Internal Revenue Service had a 20 point all or nothing standard for classifying a worker as an independent contractor and used a very heavy handed enforcement approach. Congress “defanged” the IRS about 1996 or so after an outcry from small business owners. Until the last seven or eight years, the IRS has largely left employers alone and did not perform many reclassification audits.
In the last few years, the IRS, the Department of Labor (DOL), and state agencies that collect unemployment insurance or enforce workers compensation laws have dramatically stepped up the number of independent contractor reclassification audits. To make matters worse, none of the federal and state agencies use the exact method of worker classification.
Independent Contractor Classification Rules
Generally, the IRS, DOL, and some state agencies have boiled down the issue to three broad areas that all must be considered to make an independent contractor classification:
Type of Relationship - Is the independent contractor an individual or another legally chartered entity? It is often easier to establish an independent contractor relationship with other companies rather than individuals. Benefits – independent contractors should not be getting benefits that employees receive. Permanency of relationship – Generally independent contractors are engaged for a specific project or a specific period of time. There must be evidence to support this. Written contracts – The presence of written contracts is one of the safest ways to protect the independent contractor vs. employee relationship.
Behavioral Control - Independent contractors decide how their work is going to be down, when they do it, and where they do it. Companies don’t control the way an independent contractor works or how they do their job.
Financial Control - Are the business aspects of the worker’s job controlled by the payer? (These include things like how worker is paid, whether expenses are reimbursed, who provides tools/supplies, etc.) Extent of the worker’s investment is also important to consider. An independent contractor normally provides all their tools, may have employees that work for them, and normally obtain their income from multiple sources. All independent contractors that earn over $600 a year from a company are provided an IRS from 1099 at the end of the year.
IRS form SS-8
Although it is far better to seek guidance from a knowledgeable CPA, attorney, or HR consulting firm, a company may ask the IRS to make the independent contractor vs. employee decision for them. To go this route, fill out an IRS form SS-8. Either the worker or the company may seek an IRS determination. The penalties and consequences for misclassification are steep, so it is important to review your independent contractor relationships every year so you don’t have an unpleasant reclassification audit.
