Is That Independent Contractor Really An Employee?

Is That Indedpendent Contractor Really An Employee?: How to Steer Clear of Worker Classification Woes

As a construction company owner, you may engage independent contractors to serve on a given project. These arrangements suit both parties well: The independent contractor earns a living with his or her skill set, and your business doesn't need to provide benefits or deal with the tax and insurance matters related to regular employees.

But beware: The IRS continues to be hot on the trail of any employer that, in its eyes, erroneously treats a bona fide employee as an independent contractor.

Common Law Factors

Workers are generally employees for federal tax purposes if their employers control and direct the jobs they perform and how they perform them. The IRS streamlined the process for determining worker status under common law factors developed through judicial decisions, grouping the degree of control into three categories of evidence.

The first is behavioral control, which is simply the right to control and direct how work is done. The second law is financial control, which gives you the right to oversee the business aspects of workers' activities. The last law concerns affiliation, that is, the type of relationship between the parties, including each side intent and how they perceive their relationship.

The IRS uses many factors to determine whether an independent contractor is a bona fide employee. For example, if you require the contractor to work on the premises, it suggests control if workers could perform their duties elsewhere. This may not be a huge factor if the independent contractor must work on a job site. But if a consultant could work off-site and yet you require him or her to report to your office or trailer, it could be a problem.

Another factor is whether you offer facilities and equipment. Construction workers usually rely on their employer for tools or at least an allowance to buy tools. You may be able to defend an independent contractor status if he or she shows up for work with the necessary items in hand.

Hourly, weekly or monthly payments typically point to an employer-employee relationship. To fortify an independent contractor status, pay by the job or on a straight commission basis.

A project success or failure usually doesn't threaten employees' paychecks. Conversely, those who can realize a profit or suffer a loss as a result of their services are usually deemed independent contractors.

Finally, if you have the power to fire a worker, he or she is likely an employee. Independent contractors generally can't be dismissed as long as they produce the work under contract.

Best Practices

To avoid misclassifying workers, create a questionnaire to gather facts about anyone you currently classify as an independent contractor. Then compare these facts to the common law factors mentioned above.

Also, ask independent contractors for evidence of their autonomy. Acquire copies of letterhead, invoices and business cards. If they operate through their own corporations, record their federal employer identification numbers and equivalent state numbers. Mandate written proof that they've obtained or lawfully waived coverage under workers' compensation and unemployment compensation laws.

In addition, ask your attorney to help prepare a written agreement outlining your relationship with each independent contractor that supports their classification as such. Ask new independent contractors to sign the agreement before starting work.

Penalties And The VCSP

If the IRS determines that you've improperly classified an employee as an independent contractor, you might owe back payroll and income taxes that you should have withheld. You may be liable for interest and penalties as well.

To help companies with their worker classification rules, the IRS created the Voluntary Classification Settlement Program (VCSP) in September 2011. The program incentives employers to reclassify groups of workers from independent contractors to bona fide employees in exchange for a reduction in liability for back taxes.

The IRS made substantial revisions to the VCSP earlier this year. For example, employers accepted into the program will no longer be subject to a special six- year statute of limitations rather than the usual three years that normally applies to payroll taxes. Ask your tax advisor for further details.

Follow The Rules

As a construction company owner, you understand the concept of working under a contract. So, as long as you follow the rules and document your independent contractors, you'll likely have nothing to worry about.