If independent contractors are part of your workforce, the IRS is watching.
The IRS says it intends “to end the business practice of misclassifying employees in order to avoid providing employment protections.” According to a federal report, officials from one region said, “Workers were misclassified as independent contractors at over 80% of the construction sites they inspected.” At stake is $7 billion in taxes and penalties for misclassified workers that the IRS believes it can add to federal coffers during the next 10 years, and they are hiring lots of new inspectors to go after it.
“In the ’90s when the economy was going great, the government didn’t pay very close attention to this part of the workforce,” Bernard Caputo, president of Atrium Staffing’s New Jersey practice tells Staffing Talk. “But then they realized they were losing tons of money to this group. So when the economy worsened, the feds began paying closer attention to how companies are classifying their workers, ensuring the thresholds for independent contractors are being met. And they found lots of companies aren’t in compliance.”
Non compliance can be costly, as FedEx, Microsoft and others have discovered.
The IRS assessed approximately $319 million in back taxes by FedEx for a single tax year due to misclassifying a large number of FedEx Ground/Home Delivery drivers as “independent contractors” instead of as employees. The assessment can increase when the IRS looks at other tax years for similar infractions. Class action lawsuits against FedEx involving thousands of drivers have also been initiated around the country.
Microsoft’s compliance troubles began in the late 1980s, when the company employed around 1,000 workers under the category of independent contractors. As part of their processes and procedures, these workers signed an agreement stating they were not eligible for the company’s Benefits Program for employees.
The IRS conducted an audit on the company and found those workers classified by the company as independent contractors should actually be employees. The IRS findings were based on Microsoft’s inherent ability to “exercise direction and control” over the services performed by those workers. Microsoft decided to comply and paid employment (back) taxes for the workers and even hired some of those workers as employees.
However, a group of those former independent contractors turned employees, demanded the benefits they could have enjoyed during the specific period they were classified as independent contractors. While the company disputed the claims, several of the employees sued Microsoft (Vizcaino vs. Microsoft) for the right to participate in the Benefits Plans. Microsoft settled the suit in 2007 in the amount of $97 million.
“The common thread in these cases is treating an itinerant labor force like full time employees,” Caputo says. “Companies need to isolate the contingent labor population into a bucket that’s not co-mingled with full time employees. There needs to be a distinction between how you are treating a 1099 employee versus how you are treating a full time employee. You will run into problems if you don’t.”
“Companies need to isolate the contingent labor population into a bucket that’s not co-mingled with full time employees. There needs to be a distinction between how you are treating a 1099 employee versus how you are treating a full time employee.”
Caputo knows the contingent compliance space well. In addition, to growing and leading Atrium’s thriving New Jersey practice, he developed and heads the Atrium Payroll Services company, supporting a nationwide clientele, and employing 5,000 contingent employees year-round.
He pointed out that if a 1099 worker does not pay their State, Federal or payroll taxes, the IRS can force the hiring company to pay all withholding taxes, plus interest, as far back as seven years.
“Misclassifying an employee as a contractor can violate a variety of laws covering worker compensation, taxes, unemployment insurance, and overtime. This can be an expensive mistake,” Caputo continues. “We can go into a company and accurately access which employees need to be in a W-2 framework and which can be indemnified as independent contractors. When you shift this to a third party they become responsible for the liabilities and that’s what they earn their fee for.”
One important distinction I discovered in my research is that pieces of paper you and your independent contractors sign don’t trump the law. In other words, just because your contractors sign an agreement saying they’re contractors and not employees, doesn’t mean that agreement has precedent over the legal definition.
And that legal test is, “How much control does the company exercise over how the contractor or temporary employee performs the work? Do they control the manner in which performance is accomplished?” Control is indicative of employee status.
How much control does the company exercise over how the contractor or temporary employee performs the work? Do they control the manner in which performance is accomplished?
Among the most often misclassified workers are truck drivers, construction workers, home health aides and high-tech engineers.
This New York Times article states that portraying regular workers as contractors allows companies to circumvent minimum wage, overtime and anti-discrimination laws. Workers classified as contractors do not receive unemployment insurance if laid off or workers’ compensation if injured, and they rarely receive the health insurance or other fringe benefits regular employees do.
“This denies many workers their basic rights and protections and means less revenues to the Treasury and a competitive advantage for employers who misclassify,” said Jared Bernstein, Chief Economist to Vice President Joseph Biden to the Times. “The last thing you want is to give a competitive advantage to employers who are breaking the rules.”
The last thing you want is to give a competitive advantage to employers who are breaking the rules.
In summary, distinguishing between an independent contractor against an employee, the degree of “control and direction” over the worker plays a key part. A real independent contractor is a qualified expert and do not need any degree of “control” over their manner and means to perform their services. Employees, however, usually require basic to advanced training or instructions on how to perform their work assignment.
If you are interested in reading further, below you will find the IRS checklist for 1099 versus W-2 workers
1. Must the individual take instructions from your management staff regarding when, where, and how work is to be done? A worker who is required to comply with other persons’ instructions about when, where, and how he or she is to work is ordinarily an employee. This control factor is present if the person or persons for whom the services are performed have the right to require compliance with instructions.
2. Does the individual receive training from your company? Training a worker by requiring an experienced employee to work with the worker, by corresponding with the worker, by requiring the worker to attend meetings, or by using other methods, indicates that the person or persons for whom the services are performed want the services performed in a particular method or manner.
3. Is the success or continuation of your business somewhat dependent on the type of service provided by the individual? Integration of the worker’s services into the business operation generally shows that the worker is subject to direction and control. When the success or continuation of a business depends to an appreciable degree upon the performance of certain services, the workers who perform those services must necessarily be subject to a certain amount of control by the owner of the business.
4. Must the individual personally perform the contracted services? If the services must be rendered personally presumably the person or persons for whom the services are performed are interested in the methods used to accomplish the work as well as in the result.
5. Have you hired, supervised, or paid individuals to assist the worker in completing the project stated in the contract? If the person or persons for whom the services are performed hire, supervise, and pay assistants, that factor generally shows control over the workers on the job. However, if one worker hired supervises, and pays the other assistant pursuant to a contract under which the worker agrees to provide materials and labor and under which the worker is responsible only for the attainment of a result, this factor indicates an independent contractor status.
6. Is there a continuing relationship between your company and the individual? A continuing relationship between the worker and the person or persons for whom the services are performed indicates that an employer-employee relationship exists. A continuing relationship may exist where work is performed at frequently recurring although irregular intervals.
7. Must the individual work set hours? The establishment of set hours of work by the person or persons for whom the services are performed is a factor indicating control.
8. Is the individual required to work full time at your company? If the worker must devote substantially full time to the business of the person or persons for whom the services are performed, such person or persons have control over the amount of time the worker spends working and impliedly restrict the worker from doing other gainful work. An independent contractor, on the other hand, is free to work when and for whom he or she chooses.
9. Is the work performed on company premises? If the work is performed on the premises of the person or persons for whom the services are performed, that factor suggests control over the worker, especially if the work could be done elsewhere.
10. Is the individual required to follow a set sequence or routine in the performance of his work? If a worker must perform services in the order or sequence set by the person or persons for whom the services are performed, that factor shows that the worker is not free to follow the worker’s own pattern of work but must follow the established routines and schedules of the person or persons for whom the services are performed. Often, because of the nature of an occupation, the person or persons for whom the services are being performed do not set the order of the services or set the order infrequently. It is sufficient to show control, however, if such person or persons retain the right to do so.
11. Must the individual give you reports regarding his/her work? A requirement that the worker submit regular or written reports to the person or persons for whom the services are performed indicates a degree of control.
12. Is the individual paid by the hour, week, or month? Payment by the hour, week, or month generally points to an employer-employee relationship, provided that this method of payment is not just a convenient way of paying a lump sum agreed upon as the cost of a job. Payment made by the job or on a straight commission generally indicates that the worker is an independent contractor.
13. Do you reimburse the individual for business/travel expenses? If the person or persons for whom the services are performed ordinarily pay the worker’s business and/or traveling expenses, the worker is ordinarily an employee. An employer, to be able to control expenses, generally retains the right to regulate and direct the worker’s business activities.
14. Do you supply the individual with needed tools or materials? The fact that the person or persons for whom the services are performed furnish significant tools, materials, and other equipment tends to show the existence of an employer-employee relationship.
15. Have you made a significant investment in facilities used by the individual to perform services? If the worker invests in facilities that are used by the worker in performing services and are not typically maintained by employees (such as the maintenance of an office rented at fair value from an unrelated party), that factor tends to indicate that the worker is an independent contractor. On the other hand, lack of investment in facilities indicates dependence on the person or persons for whom the services are performed for such facilities and, accordingly, the existence of an employer-employee relationship.
16. Is the individual free from suffering a loss or realizing a profit based on his work? A worker who can realize a profit or suffer a loss as a result of the worker’s services (in addition to the profit or loss ordinarily realized by employees) is generally an independent contractor, but the worker who cannot is an employee.
17. Does the individual only perform services for your company? If a worker performs services for a multiple of unrelated persons or firms at the same time, that factor generally indicates that the worker is an independent contractor.
18. Does the individual limit the availability of his services to the general public? The fact that a worker makes his or her services available to the general public on a regular and consistent basis +indicates an independent contractor relationship.
19. Do you have the right to discharge the individual? The right to discharge a worker is a factor indicating that the worker is an employee and the person possessing the right is an employer. An employer exercises control through the threat of dismissal, which causes the worker to obey the employer’s instructions. An independent contractor, on the other hand, cannot be fired so long as the independent contractor produces a result that meets the contract specifications.
20. May the individual terminate his services at any time? If the worker has the right to end his or her relationship with the person for whom the services are performed at any time he or she wishes without incurring liability, that factor indicates an employer-employee relationship.