CWS 3.0: July 27, 2011 - Vol. 3.17


Because You Asked: IC: The Pandora’s Box

As a recently appointed CW manager, I am looking to avoid misclassification risks. I realize this is a Pandora’s Box, but what’s the first thing I can do to start this process?
— Fervent in Fairfield, Ohio

Dear Fervent,
Pandora’s Box is right. But there is something you can do to start rolling the ball in the right direction. Get an understanding of your independent contractor population. Many companies don’t have an easy way of reckoning who they have engaged that might be classified appropriately. So number one, figure out who you’ve got who may be misclassified.

Begin with a self-audit. The most obvious route is compiling a list of who you’re reporting on a 1099. (A 1099 is a tax form for independent contractors that shows how much they made from a certain business. The business or company paying for the services is obligated to tender the income to the contractor, not to take out any deductions.) While you’re likely to find some 1099s who are misclassifed, not all will be, so the first draft of the 1099 list is going to be overinclusive.

Then you would want to, at least, know who decided to classify these people as independent contractors. What was the procedure? Next, evaluate the people who did the assessment. You’ll need to know if these people are qualified to make these assessments. Next, audit the people who have been classified as independent contractors. So I would recommend that you vet a large group of ICs to see if they have been classified appropriately. A third-party, reputable compliance firm can help with this process.

The results could be surprising. Your company may have been doing a good job. On the other hand, it’s very likely that there are many contractors that are misclassified and should be employees. At this juncture, it’s important to understand your best course of action. Obviously, you’ll have to change what the company has been doing. Do you reclassify the contractors? How far back do you go in your audit? What do you do? I would recommend you bring in your legal department or in-house attorney, who can work with the compliance vendor. Once these decisions have been resolved, then you can decide what process to establish for bringing contractors on board.

In today’s economy, given budgetary issues and lack of skilled talent, relying on ICs is almost mandatory. Most companies cannot afford to not use them. The trick is in coming up with a consistent standardized process that people are will follow. Universally, the reason companies have misclassification problems is lack of knowledge and, more important, people working around whatever procedures there were in the first place.

An attorney once told me it’s not about having a great procedure on paper. It’s getting people to follow the rules. Often, people are paid as independent contractors because of a hiring freeze. Often, people are independent contractors not because they have been evaluated under the IRS test, but because managers need a task done right away, and there’s a headcount limit.

Issues notwithstanding, you are asking all the right questions. Make sure you start with an audit and go from there. Given the current climate and emphasis on IC compliance, it is a good to self-correct rather than have the IRS do it for you.


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