The Compliance Wire

One of the most common and controversial issues I encounter during Independent Contractor evaluations is the topic of expense reimbursement.  This subject ties into the idea of financial control, one of the three categories that are closely examined during an alleged  misclassification.

The Big Idea: Treat Independent Contractors Like Vendors

Smart businesses seek to keep their overhead low and costs down.  Many have therefore implemented expense reimbursement policies that employees must follow. Often, we see agreements where this reimbursement policy is pushed to independent contractors. This should generally be avoided. Would you require vendors to follow a reimbursement policy?   Would you forbid your vendors from allowing their visiting employees to fly first class?  Would you require them to supply receipts to your company?

Hopefully, the answer is usually no.  Because you would not dream of reimbursing these vendors.  They understand it is the cost of doing business, and any lavish spending will affect their own ability to earn a profit. As a general rule, you should treat your Independent Contractors as you treat your vendors, not your employees.

“Reimbursable Expenses” vs. “Project Cost”, A Little Smoke & Mirrors?

Additionally, we advise our clients that any items that represent a project cost that are not part of a deliverable may be included.  However, the “costs” should be labeled as such and not as reimbursable expenses.  If your plumber bills you for the pipes and tile installed in your bathroom, these are merely project costs that he should have bid to you during his initial estimate. He’s running a business and will be able to write off the expenses. If he can’t swing it, there might be reason for concern in the stability or validity of his business.

Deal-Breaker? Perhaps not. . .

On a final note, I would like to point out that this factor on its own will not likely cause a contractor to be found misclassified.  Some companies choose to ignore this recommendation based on the anticipated cost savings.  However, if the relationship is somewhere in between employee and contractor, this may just be the factor that tips the scales (reversing any previous cost savings).  It is best practice to structure your agreements in a manner where both your cost and your risks have been minimized.

This week, come visit with members of the WorkforceLogic team at SIA’s Risk Forum in Washington DC.

Catherine Wingate, Sr. VP of Global Services for WorkforceLogic will be presenting on the topic, “Minimizing Independent Contractor Misclassification Risk: What You Need to Know.”   Along with Duff  Hall, Microsoft’s Talent Source Program Manager, Catherine will explore strategies and practices for minimizing contingent workforce risks.  We are thrilled about our expert panel and hope to see you at this event.

Also, be sure to catch our very own CFO, Steve Furtado, on Wednesday as he announces some very exciting news regarding our ever-evolving compliance program.

Intensified Spotlight on Contractor Misclassification

Be sure to check out the article featured in CNN Money today regarding independent contractor misclassification and the related crackdown. The article forecasts the eminent audits and governmental attention the issue is receiving.  The article however does not delve into the dangers of class action lawsuits – a potentially devastating side effect of misclassification.

Another Pitfall of Misclassifying Workers

While audits are both distracting and disruptive to businesses, class action lawsuits have the potential to become more costly, both in terms of dollars and image.  As class action lawsuits play out in court, they receive a great deal of media attention and scrutiny from various audiences (take the FedEx suit for instance). The related court proceedings may last for months or even years.  Even with a favorable outcome, this type of suit is not productive for business.  Add labor unions (with their interest in workers being dues-paying members) to this mix and you are in for one compliance cocktail that may be difficult to swallow.

The Usual Suspects To Share Scrutiny Soon

For now, the main spotlight appears to be in the construction and transportation related industries, including cable installation and trucking.  If you operate a business which relies on drivers, chances are you have caught wind of this.  This is not to say any industry is safe.  Misclassification cases have been seen throughout nearly every industry from baby gear manufacturers to adult entertainment venues. Clearly, given the FY11 budget and section 9006 of the recently approved healthcare bill, the government intends to expand enforcement.  I personally foresee a rise in both misclassification and wage and hour claims within the healthcare and IT industries within coming years.

Be sure to read the section on freelancers, an often controversial and murky topic for contractor classification.  What are your thoughts on freelancers with regard to contractor versus employee classification?  Your comments are welcomed below.

Does this come as a surprise?

During his days as a senator, now President Barack Obama introduced legislation to congress targeting worker misclassification several years ago.  Other proposed legislation was introduced to congress, but seemed to die on the vine.  Since his election, many have kept a watchful eye on new bills from DC, anticipating activity focused on worker misclassification.

Momentum is Building… Are you prepared?

Upon review of the fiscal year 2011 budget , allocation of funds provide a clear indication of the federal government’s intention to take a closer look at this topic. The budget includes a proposal to combat the misclassification of employees as independent contractors by “eliminating incentives in law for employers to misclassify their employees” by modifying the safe harbor provision. Additionally the budget allocates $25 million towards the Department of Labor to target misclassification, calling for 100 additional enforcement personnel to address the issue.

Low risk service types — do they exist?

In recent employment tax audits, cable installers, actors, ground-service delivery drivers, and even exotic dancers to name a few service provider types have raised a red flag with the ever so watchful IRS. So what specifically, about these service providers  rocked the IRS’s boat?   I am sorry to say that there is no definite answer, as many are the factors that will weigh in risk wise, when paying a service provider as an independent contractor. Besides,  judging by one of Massachusetts’ recent (and über strict) guidelines, one safe bet is to only engage contractors who perform services that are unrelated to your usual or core business functions.

Who controls how the worker does the work?

Businesses with a lower appetite for risk should keep in mind that 1099/Independent Contractor compliance risk mitigation will more than likely have endless shades of grey when discussed with an IRS auditor. Nonetheless, most experts will agree that it truly boils down to the amount of control that a company has over the “Independent Contractor” as well as the amount of investment that the individual has in their business.

The control factors that will tip the scale and point toward an employee type of relationship are commonly known as behavioral control.  The IRS states that behavioral control refers to facts that show whether there is a right to direct or control how the worker does the work.  The items below may be interpreted as control factors when it is the business that determines them for the worker:

• When and where to do the work
• What tools or equipment to use; especially if the equipment is provided by the business
• What order or sequence to follow when performing the work
• Attend staff meetings
• The services are provided onsite at the business’ location
• Degree of instruction
• Training.

A worker is an employee when the business has the right to direct and control the worker.

Amount of Investment in the Business

In contrast, the amount of investment a person has in his or her business will also weigh in to the IRS’s assessment.  Investment in business, meaning, what steps has the independent contractor taken to differentiate themselves from an employee and substantiate their status.

To preserve your IC status, a legitimate independent contractor should consider these basic items to avoid being reclassified as an employee:

• Make services widely available (business card, website, vs. word of mouth)
• Have multiple clients
• Work off site
• Obtain all necessary licenses/permits

Take into account that no specific factor (behavioral control, financial control, or type of relationship) will solely offset the IRS worker classification scale the next time your business decides to categorize a certain service type as “low risk”.  As the cable installers, actors, ground-service delivery drivers, and exotic dancers await a ruling on their cases, the IRS will continue to suitably weigh in all the details and formulate a decision based on the overall blend of these factors.

The truth about 1099 contractor use from an insider’s perspective:

On any given day, dozens of phone calls are fielded from businesses wanting to know the appropriate classification for their workers. In a time of economic hardship, many companies are turning to independent contractors to fill voids during an unforgiving budget crisis. These proposed ‘independent contractors’ will sometimes have a desk, name placard, computer, phone with client supplied voicemail, and many other employee like resources. A common thread among the hiring companies is the assumption that if the worker believes themselves to be an independent contractor then it must be true. The truth is that while the relationship may seem valid at the time of engagement the amount of control often begins to increase as the term of the relationship lengthens.

It has been a difficult fiscal year for many workers, independent contractors being no exception. For many small businesses, work is hard to come by, so when a good opportunity comes along for a long term contract many independent contractors are jumping on it. There is a chance that an alleged 1099 worker is actually hoping to gain full time regular employment, which would include employee benefits. In fact, a recent article published in New York Times  indicates that labor data is showing a surge in the hiring of temp workers, extended hours for part time workers, and the use of freelancers. Freelancers are a great example of workers who are typically considered 1099 independent contractors, though not guaranteed this status in the eyes of the IRS.  The question becomes, is this individual acting as such?

Can 1099 Contractor Use Save My Budget?

In a time of economic uncertainty many companies are willing to become gamblers. How significant are the consequences in relation to risk? This depends on how much time, money, and resources a company has and is willing to use to fight a reclassification case. A feasible solution for organizations would be to make an effort in controlling their IC population. Proper usage of these workers can save a great deal for client companies, while improper use may warrant fines, penalties or even full blown audits.
Be aware of who is coming and going. Without a doubt, verify the relationship at some level even if that means collecting some basic business documents from the contractors such as advertising/marketing materials, business expenses, and a business license. While these steps will not guarantee protection, they are at least a step in the right direction. What will your company’s New Year’s resolution be?

Let the crackdown begin!  As many of you have heard, and as my colleage Katya mentioned last week, the IRS has given clear indication of plans to step up enforcement efforts and employment audits around misclassified workers, and increase  penalties for such offenses.

Increased 1099 Awareness May Lead to Private Right of Action

Something to consider: More and more 1099 workers are hip to this crackdown and are reevaluating how they are being treated and classified by their ‘clients’. A case filed for $200 million against Northwestern Mutual Life Insurance Co. by a few of their independent contractors involves action on behalf of the workers.  They are claiming that they were misclassified and were being treated as employees without receiving minimum wage and overtime pay.  As this trend is spreading, and the word is getting around, my advice is to beware and revaluate the relationship you have with your independent contractors.  Here are a few Helpful Hints to help protect your business:

Three main factors that can help you protect yourself from a worker misclassification suit or employment audit:

The first one is to do a bit of research on the Contractor you are engaging.

• Perform an internet search on the contractor. Find out if they have a website, have formed a corporation, and are they paid on a Federal Tax ID Number.  These are just a few hints that indicate a significant investment in their business.  These items also help to demonstrate an independent business and thus independence from your business, which is what you want.

The second is to review your relationship with the Contractor.  The big issue to concentrate on is CONTROL.

• The only thing that should be approved by you is the end result.
• Do you have to train them?  There should be no training involved.  The reason you are engaging a contractor should be for their specific expertise.
• No financial control!!  A true business or contractor should have the opportunity to realize a profit or loss.
• The independent contractor in most cases should not be using your equipment, email, voicemail, or representing your company. Separation is key!

The third component would be to review the contract and relationship between you and the Contractor.

• What is the contractor’s expectation of the relationship? Is this going to be his main gig and source of livelihood? Or are you just a short stint among his other clients?
• How are the payments laid out?  Avoid hourly, bi weekly, and “expense reimbursements.”  This is how an employee is paid.  A contractor should be paid upon deliverables for a specific project, with all associated costs factored into their overall total.
• A project should typically not extend beyond a year.  Make sure to have set start and end dates. If you need this individual longer than a year they might become an integral part of your business and should be hired on as an employee.
• Verbiage!!   Any employee- type verbiage such as “as needed,” “managing a team,” “training,” “reports to” is verbiage indicative of an employee relationship.  The PROJECT should not be mistaken for a JOB DESCRIPTION.

These are just a few of the ways you can review how you are doing business with 1099 contractors, and a way to protect yourself.  Of course we always recommend that you seek a professional service if you tend to utilize a high volume of contractors, such as WorkforceLogic!