Correctly classifying independent-contractors to avoid penalties.
It's well known that the minimalist company's favorite worker -- the independent contractor -- is under assault by the Internal Revenue Service. The tax collector is hunting for an estimated $8 billion in payroll taxes forgone because workers have been misclassified. What's not so widely appreciated is that midsize and small companies are among the most vulnerable. "Larger businesses tend to know their rules better," says Janet Goldberg, a partner at Sachnoff & Weaver, a Chicago law firm.
Small businesses often don't -- and they're more likely to let employees drift into intermittent working arrangements. Describing a worker as an independent contractor also saves companies a bundle: pension, group health, and workers' compensation expenses, as well as social-security and unemployment taxes.
The most common mistake employers make? "A lot of companies are treating workers as independent contractors, but they have no written agreement with them," says Suzanne McCarthy, also a partner at Sachnoff. Contracts should address the central issues that determine whether a worker is truly an independent contractor, and should specifically include --
* A statement that the independent contractor is not entitled to employee-benefits programs.
* A joint-severability clause stating that if part of the contract is struck down, the rest of it survives.
* Acknowledgment that the independent contractor is free to work elsewhere at any time.
The other most common mistake is for companies to assume that because a worker toils at home or maintains unusual working hours, that person is an independent contractor. Actually, such workers may be technically considered part-timers, eligible for benefits and subject to withholding taxes, just like full-time employees. Here is a handful of the 19 criteria the IRS uses to classify a worker. A yes answer suggests the worker has the characteristic of an employee, but it's up to the auditor to decide if a number of yes answers calls for a reclassification of the worker.
* Methodology. Is the worker required to follow the employer's direction about when, where, and how he is to work in order to get the job done?
* Continuing relationship. Does the employer rely on the worker exclusively to perform work at frequently recurring intervals, even when such work is part-time?
* Dispensability. Does the success of the business depend upon the performance or service of the independent contractor?
* Oral or written reports. Is the worker required to submit reports to "account for his actions?"
* Significant investment. Does the employer furnish equipment, office space, furniture, machinery, and so forth required by the worker to perform her work?
Not all 19 tests are equally weighted. In fact, the most important indicator of "independent" status is whether a worker's services are available to the general public, according to Bill Kuzmin Jr., president of Paladin, a labor-relations consulting firm in Flanders, N.J.
If you've negligently misclassified employees, the penalty can range from the amount that should have been withheld to double that. Criminal penalties are far stiffer -- a $100,000 fine for a corporation or a year in prison, or both -- but are rarely levied. The IRS will often waive penalties if you agree to correctly classify workers in the future. -- Ellyn E. Spragins