If you need to exert full control over a worker’s output – how, when, and where they get the work done, then you should categorically avoid hiring independent contractors in favor of full time employees. Period. Full stop. If your motivation for hiring independent contractors is purely driven by a desire to save costs on insurance and other benefits you should definitely avoid hiring ICs as well. There are good, actual reasons for engaging independent contractors and there are concrete means for determining who can legally be classified as such. Know what they are or suffer some pretty ugly consequences.
Did you know that one in three companies fail a worker classification audit and 46 percent of independent contractors reviewed by the IRS are found to be misclassified? Its true! According to a recent article in Entrepreneur magazine, “Financial consequences include penalties which have “tripled, quadrupled” since the enactment of the Affordable Care Act. These penalties can easily stretch into millions of dollars. Add in hefty attorney fees and considerable man-hours, and you’ve got a big hit to your bottom line. With more and more workers joining the ranks of IC’s – and fewer and fewer tax dollars being collected by the federal government as a result – the feds are stepping up efforts to bust companies who are skirting their tax liabilities by classifying workers as contractors. Chances of a classification audit today are much higher than they were even 5 years ago.
At the same time, workers who are growing bitter at exploitive practices of organizations using ICs to maximize profitability at the expense of workers’ benefits are engaging in class action lawsuits. “Groups of independent contractors requesting employee status are becoming increasingly common” according to the Entrepreneur piece, making this type of suit one of the hottest areas in employment litigation. Between the increased audit risk and the litigation risk, it has never been more risky to improperly classify ICs (accidentally or otherwise).
In either case, it is important to have a clear conception of the actual rules as enunciated by the IRS for what constitutes an employee and what it means to be a true IC. The older IRS 20-point checklist is still very relevant and a good starting place for building your own worker classification policy. This link contains information culled from the IRS explaining both the 20-point list as well as the more recent “1099 versus W-2” classification guidelines, which focus on three main factors providing evidence of the degree of control and independence:
1. Behavioral: Does the company control or have the right to control what the worker does and how the worker does his or her job?
2. Financial: Are the business aspects of the worker’s job controlled by the payer? (these include things like how worker is paid, whether expenses are reimbursed, who provides tools/supplies, etc.)
3. Type of Relationship: Are there written contracts or employee type benefits (i.e. pension plan, insurance, vacation pay, etc.)? Will the relationship continue and is the work performed a key aspect of the business?
The bottom line is, worker classification is critically important and with the growing challenges from numerous quarters, it is something a strong workforce management program needs to have well in hand so as to avoid costly fees, fines, penalties, and damaged reputation.