Written on June 17, 2010 at 6:48 pm, by HRDyn

Few issues in Human Resource (HR) management are more problematical than the legality of Independent Contractors (IC) who are “1099ed” by the business employer. Small businesses cannot usually afford an in-house professional to manage this employment issue. But, hiring IC’s, who are really employees, to avoid the headaches of pay-rolling and governmental reporting is a dangerous path. Instead, carefully selecting an out sourced supplier of HR is the answer.

Business owners may try to save money by not pay-rolling a new hire; especially if the owner is uncertain how long the worker will be needed at the company. But the Internal Revenue Service (IRS) and state agencies demand assurances that the employee is not misclassified as an IC, thereby avoiding employment laws, worker’s compensation, unemployment taxes and the employer’s contribution to FICA and Medicare.

Misclassifying employees as independent contractors to avoid employment laws and taxes can result in stiff penalties as well as payment and interest for all prior period employment taxes. As you might expect in these tight budgetary times, both the federal and state governments are increasing the employment audits of small businesses.

Another trap for the business owner is that independent contractors who are injured, quit or are fired from a job may end up petitioning the IRS to have their independent contractor status predetermined so they can be eligible for unemployment insurance and medical payments under worker’s compensation. This will bring the IRS and state agencies right to the employer’s front door.

The key is for the company to properly classify the worker as an Independent Contractor (IC) or a “W-2 Employee”. A good place to start is the 20 common law rules published by the IRS. These rules ask questions to test the relationship such as….

• Does the person’s business have a registered name?
• Does the person have more than one client?
• Does the person advertise?
• Are there unreimbursed business expenses and ongoing fixed costs?

Another IRS test addresses the behavior of the relationship. Does the company control what the worker does, how the worker does the job and hours to be worked?

Finally, to better define the relationship there should be a written contract with the worker with a time frame for the specific project or job to be completed.

If a company currently has employees who are misclassified as IC’s or wants to “hire” IC’s in the future, there are basically two options: petition the IRS or use a third party staffing company. To petition the IRS use form SS-8, “Determination of Worker Status”. The IRS will provide a classification for the specific job but it can take up to six months to get the determination.

The second option, well suited to small and mid size businesses, is to use a third party staffing company; either a temporary staffing agency or a Professional Employment Organization (PEO).

The temporary staffing agency need not be involved in recruiting the worker, but should be involved in verifying immigration status and perhaps credit scores. The staffing company then provides the worker to the company for a specific time period and becomes responsible for required tax withholding, employer’s FICA and Medicare contributions, worker’s compensation, federal and state unemployment taxes and payroll administration. The second type of third party staffing company is a PEO. To use a PEO the company must assign all of its employees and IC’s it wants to reclassify to the PEO who “leases” the employees back to the company. The IC’s become employees of the PEO, which is responsible for the payroll and statutory benefits. Unlike temp staffing, the PEO can provide health and insurance benefits, generally at reasonable costs due to their buying power. The PEO typically charges an administration fee of 3-4% of total payroll. Most PEO’s provide much more than payroll administration and benefit plans. As “co-employers”, the PEO must stay current and knowledgeable of labor law. They work closely with the company to educate and assure compliance with the alphabet of employee regulations: OSHA, FICA, FMLA, EEOC and provide Employment Practices Liability Insurance (EPLI).

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