I recently asked readers if they had any questions they wanted me to tackle. Here’s the first one. It comes to us from Kurt, a CEO in Wisconsin: “Our company relies on outside expertise for some functions. What’s the backstory behind the sudden flurry of investigations for employee misclassification for hiring freelancers, and how can I avoid this witch hunt?”
Kurt, however you label the government’s imperative to root out, fine and penalize businesses for misclassifying employees as independent contractors, it definitely is the government’s latest way of funding programs it mandates but doesn’t itself fund (like extending unemployment benefits beyond the available money pot). Unfortunately, it is again at the great expense of many business owners doing their legitimate best to run an ethical business during trying financial times.
State governments are indeed joining forces with the IRS and Labor Department, using the “misclassification” club to fine business owners to make up for tax revenue shortages. Wisconsin, as an example, is one of more than a dozen states that have collectively set a goal to investigate 6,000 employers who, the U.S. Treasury says, may have misclassified employees as independent contractors or freelance workers. There is no proof of illegal activity – an audit can be triggered by the simple and correct act of filing a 1099 form, a requirement when hiring contracted workers.
However, since September 2011, asserted a recent article by The Wall State Journal, the Labor Department acknowledges that “the government has collected $9.5 million in back wages for more than 11,400 workers who were misclassified as independent contractors by their employers.” It is important to note that not all of those companies did anything that a reasonable person (or even an experienced tax law attorney) might have concluded was outside employment law. And that’s what has business owners and boards of directors playing defense. Every line manager should be aware of the rules when asking to hire an independent contractor for a job.
Angela Heim is the owner of The Employer Group, a Wisconsin PEO organization that co-employs the employees at client worksites, sharing responsibility and liability for employee management. The company has won awards for its ethical business practices. “The atmosphere right now with regard to these ‘misclassification’ inquires definitely is really more of a prosecution or persecution than an investigation,” she said. “We’ve never had a challenge for years and years, and in one quarter, we had four client companies who unexpectedly became targets of these investigations. The time and cost involved to defend the charge of labor practice violations is a real burden and threat to a business that is, in fact, operating in the full spirit of the law.”
The U.S. Treasury estimates it could add $8.71 billion in tax revenue over the next decade – if only employers would properly classify its workforce. “Trying to make up for the government’s own shortfalls is really what’s behind this initiative,” agreed a prominent labor attorney who requested to comment anonymously due to the remarks he was about to make regarding his own industry: “It’s a sad commentary that these investigations leave a big target painted on the accused businesses. They then are susceptible to a whole new litigation line for aggressive attorneys. Once the business is fined and penalized for misclassifying an employee – at least an ‘employee’ in the court’s definition – it becomes liable for other benefits, such as vacation time, etc. Suddenly the business finds itself mired down with more legal problems – this time at the behest of attorneys who follow these cases and then contact the worker involved with the suggestion of a suit.”
Tips to safeguarding your business:
Kurt, don’t throw out the baby with the bathwater. Continue to rely on outside contracted expertise, but do it with these rules and tips front and center — and if you have further doubts or questions, do consult with a tax attorney in your state, as I’d advise any manager.
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•Understand the terms and definitions. Independent contractor: An individual operating under a business name, maintaining a separate business checking account and business records. They may hire their own employees, and they definitely advertise their services. They invoice, supply their own tools and set their own hours, and have more than one client (this can be key; make sure you aren’t the only client serviced by your free-lance consultant pro independent contractor!). An employee performs duties dictated or controlled by others, is given training for work to be done, and works for only one employer.
•If you are hiring a startup business consultant who doesn’t have other clients yet, verify that they are actively marketing or advertising their services. Keep a copy of those marketing materials on file if possible. You want to show due diligence later.
•Issue a Form 1099 for all independent contractors. This is a critical practice; the first red flag. Make sure that all contractors issue invoices for their work; don’t set up an automatic payment schedule like you would for a payroll account. Pay on receipt or within the timeframe dictated by the contract.
•Remember the “independent” clause: You don’t and cannot control an independent contractor. You can set deadlines, but not work hours. Avoid assigning tight deadlines that would require full-time attention to your business at the expense of other clients, or you’ll be in the danger zone with the IRS. Don’t provide office space or equipment unless it’s absolutely necessary to the task at hand. Don’t reimburse for expenses like gas, phone, etc.
•Hire contractors who have legitimate business entities rather than ones who operate as sole proprietors. Ask for their federal ID (FEIN) number versus a social security number.
•Don’t even reference your employee handbook with an independent contractor – it doesn’t apply to them. Don’t ever, ever refer to them as an employee of your business.
As president of a company that needs to compete on a level playing field, I applaud investigation of true corporate malfeasance. However, this is a case of the government going after low-hanging fruit in a garden of its own planting, due to vague, misleading and confusing tax code language. Even people with years of experience in employment law and application are scratching their heads at the moving target definition – and changing court definitions – of contracted labor, which is a critical resource for many businesses. Being aware of the law and showing due diligence to comply is always your best defense.
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