Rules for Engagement to Prevent Misclassification

With recent shifts in focus towards stricter employee classification enforcement, it is becoming increasingly crucial to evaluate your approach before doing business with independent contractors and small businesses. Here are just a few general tips to consider before engaging in this type of relationship.

Create an agreement that defines a specific and closed-ended project.

This agreement should be detailed enough to define the expected deliverables, dates and total amount of the project. When creating the agreement, be careful to focus on a specific project, which should be filled by a contractor, rather than a general need (more indicative of an employee relationship). The agreement should focus more on the expected outcome of the project and less on the methods of achieving this outcome. Not enough emphasis is often placed on this agreement, which is crucial in defining the relationship.

Use contractors who have already established their business.

It is important to ensure the contractor has solidified their status as a contractor before engaging in an agreement. Expertise and experience aside, new research from the U.S. Bureau of Labor Statistics indicates that most failures of American startups will occur in the first two years of their existence. All it takes to initiate an audit of your company is one former 1099 heading to the unemployment office and filing an obstructed claim.

Avoid immediately rehiring recent your W2 employees as contractors

Paying out a 1099 and a W2 to the same social security number in the same tax year not only signals a red flag out for auditing agencies, it loops back into the topic of engaging with an unestablished businesses. It is best to incorporate a break in service to let the contractor establish other clients and invest in their business. Becoming the workers primary source of income sets the business up for failure and makes the relationship look more like an employee-employer one.

Key word = Independent

Ensure the relationship and work agreement reflect that your contractor is operating independently. IRS and state auditing agencies focus on three areas of concern: behavioral control, financial control and the relationship of the parties overall. This all boils down to control and independence. Review each of these factors and ensure that the independence is being maintained. Ensure the contractor has not become an integral part of your organization and is instead an independent worker who has been utilized to provide a specialized and closed ended project.

For more information regarding employee classification guidelines be sure to visit the IRS website.