Gallagher and Hraha started as contractors themselves. They had been working for a title-insurance company. "I was in the judgment department," Gallagher explains. "The company purchased a computer database and basically eliminated my job." The company needed deliveries made, but cheaply. So the insurance agents asked Gallagher if he wanted to make deliveries as an independent contractor, and they set him up with Hraha, whom they'd employed as a delivery driver.
Stripped of benefits and job security, the pair began making night deliveries by car and meeting in the wee hours to take a break and plan their growth. While dropping off deliveries for the title company, they found they could pick up others and grow a real business. Their instincts were dead-on: after a few years they couldn't handle all the deliveries alone. A lawyer told them -- correctly at the time -- that the industry's employment standard was to use independent contractors. So they used contractors.
That was long before the IRS and the IDES began their new round of crackdowns. The trouble started in 1989, after Quicksilver's laid-off office manager applied for unemployment benefits. He'd been an employee -- one of the few there -- but the words courier service on his application sent up a red flag. Later Gallagher received notice that the state would be auditing Quicksilver, first for the tax years 1987 and 1988, then for 1989 and 1990. He's spent the five years since tangled up in two chains of audits, hearings, and appeals at the state and federal levels.
The auditor, Gallagher says, was surprisingly polite. "He's a foot soldier, very unbiased, just there to collect numbers." The hearing that followed his audit was more contentious. Gallagher showed up at the offices of the state Department of Employment Security at 9:30 a.m. with his lawyer, his accountant, and a consultant who had worked for the department.
In nine hours of testimony, Gallagher tried to prove that the service his couriers performed was outside the usual course of Quicksilver's business -- that his company was a "brokerage" that referred customers who needed deliveries made to independent contractors who made those deliveries. The IDES wasn't buying. (Would you?) The official decision stated: "The customer believes an account with Quicksilver is an account with that messenger company alone, and that the messengers are merely agents or representatives of Quicksilver." The IDES assessed $15,000 in back taxes and penalties. Getting that one scalding decision cost Gallagher $25,000 in professional fees.
Now Gallagher has taken the state audit to the second level of appeal. But no courier service has yet won a worker-classification case in Illinois, and it doesn't look as if Quicksilver will make history. "We'll take it as far as I can financially afford to take it," he says.
It gets worse. The state audit automatically triggered a letter of liability from the IRS, which presumes guilt and sends a bill, which a company can contest. Quicksilver lost the IRS audit, which found that the courier owed $80,729 in back taxes. Gallagher is appealing that decision, too. He doesn't expect to win in court, though; his lawyers tell him his only chance is to win an exemption for the entire industry from the state legislature .
So Gallagher has become a reluctant crusader for his competitors, too. "I backed into this," he insists. "But every day you get more involved." As he nears the audit endgame his reluctance grows. He knows that when he loses the last audit battle, he'll have to cut a deal if he wants to avoid bankrupting his business. Commonly, the IRS tells a company it will forgive past debts if the owner agrees to reclassify its workers as employees. But if he cuts a deal, he's a poor crusader.
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The IRS uses a notorious set of 20 common-law guidelines to determine a worker's status. For instance, the more training a worker receives, the more he looks like an employee. If a worker's services are integral to business operations, she looks like an employee. Workers who furnish their own tools look more like independent contractors.
There is some brutal justice in the IRS's guidelines. They tell owners and workers that they can't have the best of both worlds. But the guidelines are vague and arbitrary. Not all of them apply in every case, and they aren't weighted, so you might pass all but one test and still fail.
The recent crackdown isn't the first; the IRS aggressively pursued misclassification of workers in the mid-1970s. But companies complained so bitterly that Congress passed a safe-harbor provision, Section 530, allowing continued and unending use of independent contractors without penalty if businesses could qualify on three counts: first, they had to have filed their 1099 forms faithfully; second, they had to prove "consistent use" (in other words, all workers had to be contractors -- there could be no mix of employees and contractors); and third, they had to prove "reasonable basis" (that is, that they were relying on industry practice or a long-standing precedent). Intended as a stopgap, the statute was extended indefinitely.
The IRS laid off for a while. Meanwhile, use of contractors rose. In 1985 nearly 12 million taxpayers filed returns as sole proprietors, a group that includes independent contractors; by 1990 the number had grown by 3 million.
Of course, much of the increase was legitimate -- part of a watershed in the way America works. But some of it wasn't. Faced with a tough business climate, some companies decided that reclassifying employees as contractors was a cheap way to get the same work done. Workers were in no position to argue.
In 1985 the feds test-audited independent contractors in seven districts and found widespread misclassification and unpaid taxes -- lots. Since then, the IRS has been sowing mines all over Section 530's safe harbor. Assisted by computerized processing of tax returns and information shared with state agencies, the IRS has stepped up its audits of companies that use independent contractors. Congress originally instructed the IRS to interpret Section 530 liberally. Businesses say that lately it's easier for a camel to pass through the eye of a needle than for them to gain safe harbor.
