Governmental agencies at the federal and state level are increasingly reviewing the independent contractor classification of individuals performing services for businesses. Audit activity has increased significantly in recent years in this area of the law, and Congress is considering enacting a new statute addressing this issue. Governmental agencies such as the IRS, EEOC and Department of Workforce Development – Unemployment Compensation Division as well as Workers Compensation Division – all have distinct tests that apply in analyzing the classification of an individual as an independent contractor.
Moreover, such classification also involves court and agency interpretation as to the control and direction of the independent contractors as well as other related issues. The incorrect classification of independent contractors can lead to assessments of back taxes, penalties and interest.
As a guideline for employers in hiring independent contractors, the following is a list of 10 recommendations:
Use written agreements. While not a guarantee, it can be very helpful to tip the balance in favor of holding that a worker is an IC and not an employee. Caution: Be very careful with language used (i.e., do not refer to wage or salary, but rather payment or settlement; do not refer to an employee handbook; refrain from language, policies, or terms that appear to be employment-like. For example, do not include language indicating that the IC relationship can end due to job misconduct or poor performance. Rather, simply retain the right to end the IC relationship without notice, if at all possible.).
The ICs should determine where and how to accomplish a job. Direction and control are still key factors reviewed by auditors in all areas of governmental regulation. The key point is that if a business engages in close supervision or set work hours, it is much more likely to result in a finding that the worker is an employee. The best scenario is that the only control exerted by a business is related to accepting or rejecting the final results provided by the worker.
Obtain ICs’ taxpayer ID numbers at the outset of the business relationship. In some states under certain statutory tests, obtaining the IC’s taxpayer ID numbers is required. Indeed, even if there is absolutely no direction or control of the worker, in certain states that worker would be classified as an employee if the IC’s taxpayer ID numbers have not been obtained and kept on file. The worker should fill out and sign IRS Form W9, request for taxpayer information number, before the job is started. Maintain the document in your files, but do not file with the IRS.
Hire incorporated ICs that have other clients. Incorporated ICs are much less likely to be viewed as employees compared with sole proprietors who are running unincorporated one-person operations. Moreover, if your business is the only one from which the IC receives income, the individual from the incorporated entity still could be found to be an employee.
Require invoices for payment. Do not pay ICs on a weekly, bimonthly, or monthly basis on the same schedule as your employees. Instead, require an invoice for payment, and then make a payment as you would with any other outside vendor.
Avoid entering into a non-compete with an IC. Such an agreement on its own likely will be viewed as indicative of an employment relationship.
File all required 1099s.
ICS should provide their own equipment and office space. If your business provides equipment and/or office space to your IC, it is more likely that he/she will be classified as an employee. However, if the needs of your business are such that you must provide ICs with equipment or office space, you must charge them for these items. It is also recommended that the IC should be required to sign an equipment or office space rental agreement.
Be consistent in your use of ICs. The work performed by your actual employees should be different than work performed by ICs. For example, you would not want to use both employees and ICs as bookkeepers. If this is impossible in your business, you will likely lose an IRS safe harbor protection and make it more difficult to win an audit at any level.
Keep good records. Establish a file containing the IC’s contract, all invoices, copies of 1099 forms and any other information demonstrating that the worker is operating an independent business. This could include correspondence on the IC’s letterhead, business cards, records of insurance coverage from the IC or a third-party insurer, and any correspondence from the IC’s employees. Maintain your IC file separate from your employee personnel files. Also, if possible, have a separate manager handling the ICs than someone handling employees such as in the HR Department.
