Thursday, July 18, 2013

Small Business Regulatory Nightmare:

the IRS & DOL's focus on Independent Contractors

As an HR outsourcing and management firm, one of the liabilities we uncover most often relates to the use of 1099 Independent Contractors (ICs).

If you have relationships with vendors you consider ICs whom are later determined to be employees, you may be liable for back taxes, wages, benefits, penalties and interest. Additionally, an audit by the Department of Labor for IC issues may spill over to include an audit of Exempt/Non-Exempt Overtime practices, making an existing problem even worse. Let’s take a look at the issues, and also what gets employers into trouble.

Multiple Definitions Cause Confusion

Some of the confusing things about the law are the number of exceptions and lack of a clearly defined standard or reference that employers can turn to. Also, the Internal Revenue Service defines an Independent Contractor slightly differently than the Department of Labor.

From the Internal Revenue Service:

“The general rule is that an individual is an independent contractor if the payer has the right to control or direct only the result of the work and not what will be done and how it will be done.”

However, in Fact Sheet #13 from the US Department of Labor Wage and Hour Division we are told:

“The U.S. Supreme Court has on a number of occasions indicated that there is no single rule or test for determining whether an individual is an independent contractor or an employee for purposes of the FLSA. The Court has held that it is the total activity or situation which controls. Among the factors which the Court has considered significant are:

  1. The extent to which the services rendered are an integral part of the principal's business.
  2. The permanency of the relationship.
  3. The amount of the alleged contractor's investment in facilities and equipment.
  4. The nature and degree of control by the principal.
  5. The alleged contractor's opportunities for profit and loss.
  6. The amount of initiative, judgment, or foresight in open market competition with others required for the success of the claimed independent contractor.
  7. The degree of independent business organization and operation.

Further, the court has held that there are certain factors which are immaterial in determining whether there is an employment relationship. Such facts as the place where work is performed, the absence of a formal employment agreement, or whether an alleged IC is licensed by State/local government are not considered to have a bearing on determinations as to whether there is an employment relationship. Additionally, the Supreme Court has held that the time or mode of pay does not control the determination of employee status.”

Practical Concerns

In our experience, there is a large percentage of ICs that would likely be considered employees under the various Federal Labor laws.

Most employers fail the test under both standards with regard to the way they manage their ICs. Too many times, ICs are directed daily by Managers as to the specific aspects of their job such as work hours, work location, and other specific aspects that allow the supposed Independent Contractors little or no “independent” decision making or control.

It is also interesting that in the majority of cases, the reason that the problematic Independent Contractor situations occur is because the employer was trying to avoid providing a specific position or person benefits and/or paying the related payroll taxes associated with a full time employee, usually due to budgetary constraints.

If you are trying to avoid such expenses, creating an “Independent Contractor” position that may subsequently be challenged by the government is probably not the best solution.

Alternative Solutions

The alternative to an Independent Contractor in most cases is a full time employee.

However, we have also been able to provide satisfactory solutions in certain cases by using leased or temporary employees. In this case the payroll taxes and in some cases benefits are being paid, but under the Tax ID number of the Leasing or Staffing Firm, not the employer.

We strongly suggest that you review any Independent Contractors you have, especially if you are issuing a related 1099 using the seven DOL factors and the IRS definition mentioned above. The issues can be confusing, but the cost of non-compliance is high.

To contact NovationHR, please visit our website.

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