Uncle Sam Looking Closer at Independent Contractors

If your small business frequently hires independent contractors to work on projects, you might want to take a second look at the job description.

On Monday, New York became the 15th state to partner with the Labor Department in a campaign against employee misclassifications; the agreement enables information to be shared between state and federal departments on the businesses suspected of mislabeling employees.

“This is important, because they’re all enforcing different laws, each with its own penalties,” says Tammy McCutchen, a shareholder at employment law firm Littler Mendelson and the former administrator of the Wage and Hour Division at the Department of Labor under George W. Bush.

McCuthen says misclassification of employees has been a top priority at the Department of Labor and the IRS for the past three years. Classifying workers as independent contractors rather than as employees can mean less money for Uncle Sam, since businesses don’t need to pay payroll taxes or unemployment insurance for independent contractors.

For small business owners, greater sharing of information between government agencies will mean an even more expensive headache, in the event that the business is found guilty of misclassifying workers. McCutchen says business owners found guilty have to pay back the money owed with interest, often in addition to penalties.

McCutchen shares her three tips for making sure your business isn’t at risk:

No. 1: Take a second look at your independent contractors.

“My advice is: Don’t put your head in the sand. Evaluate whether they’re really independent contractors,” says McCutchen. The reason why so many businesses try to get away with hiring workers as contractors rather than as employees is that the definitions of these two categories is very fuzzy, she says.

Broadly speaking, the difference between the two has to do with control: If you’re controlling where the person works, how they work and when they work, it’s likely the government will view the person as an employee, rather than as an independent contractor. McCutchen says it’s a red flag to pay contractors by the hour rather than by the project; it’s also suspicious in the eyes of the government if your business is the only client for an independent contractor.

No. 2: Don’t hesitate to reclassify.

“It’s never too late if you don’t have them classified correctly. Every new day is a new day of potential liability, and the only way to reduce or eliminate risk is to reclassify,” says McCutchen. While you may still be found guilty of misclassifying employees, McCutchen says you’re better off reclassifying now and hoping the statute of limitation passes in your state than continuing in the same pattern, which will end up being even more costly down the road.

While it’s possible that reclassifying an independent contractor may make your business vulnerable to a lawsuit from the worker, who hadn’t been receiving benefits during his or her time as a contractor, McCutchen says it’s unlikely.

“I can’t tell you there’s no risk, but employees are generally happy to be taken on as employees and therefore most of the time are not going to be suing you,” says McCutchen.

No. 3: Consider hiring an outside auditor.

Because the government is making misclassification a major priority, McCutchen says it’s crucial that businesses that are reliant upon independent contractors make sure they’re squared away in the eyes of the law.

“Even if you have limited resources, this is the issue to be focusing on,” says McCutchen, who says it’s well worth it to have an outsider take a look at your business practices if you frequently use contractors.

“This really is the perfect storm right now. The IRS sees it as a revenue generator; states with budgetary problems see it as a revenue generator; and unions see it as a big issue, because independent contractors can’t be organized,” says McCutchen.