Misclassification Remains on State, Federal Government Radar

Small business owners who want to use independent contractors need to be sure these workers really aren’t employees.

Federal and state government agencies are on the lookout for businesses that use independent contractors, or freelancers, to evade Social Security, Medicare and unemployment taxes and workers compensation and disability insurance. Companies that are audited and determined to be using employees misclassified as independent contractors face fines.

“The penalties for non-compliance can be significant,” warns Wendy Silver, owner of Beyond the Workplace, a human resources consultancy based in Needham, Massachusetts. She suggests owners consult an attorney to before classifying a worker as an independent contractor.

The IRS has criteria by which it measures who’s an employee and who isn’t. Much of the criteria has to do with control over the employee. For example, who determines where and when the worker is at work? How closely is the worker supervised? Who purchases tools and supplies? Can the worker do work for other people or companies? Is the worker paid by the hour, weekly or other time period, or instead receives a flat fee?

The IRS, as it does in many issues, looks at the totality of circumstances. So if all the criteria point toward the worker, for example a graphic artist, being an independent contractor, the fact that the worker is paid by the hour won’t necessarily turn this into an employer-employee relationship.

The relationship itself is another key factor. Are the services the worker provides a key aspect of the company’s regular business? Officials might look to see how the worker’s assignments compare to those of a company’s full-time staffers.

“But make sure they’re not doing the same thing as your employees,” suggests Michael Boro, a consultant with PwC whose expertise is in workplace issues.

Owners can find out more about the government’s criteria on the IRS website, www.irs.gov.

Companies can be audited randomly, or federal or state officials could be tipped off to possible misclassification in other ways. If there’s something suspicious about the 1099 forms sent to independent contractors, the IRS might want to investigate further. State officials often look at unemployment tax payments. If an independent contractor sues the company, the government might want to investigate.

Some owners might want to use an independent contractor rather than temporary employee. But the two are not interchangeable, warns Kyle Lawrence, owner of Berkshire Payroll Tax, a Sandisfield, Massachusetts, company that helps businesses comply with employment tax laws. If the worker fits the government’s criteria for an employee, a business can’t call the worker an independent contractor.