8 Tips for Proper Worker Classification

Incorrect worker classification carries tremendous financial liability resulting from penalties and employment taxes. The liability can grow significantly based on the total number of tax years in question as well as how many independent contractors an organization engages. The compliance landscape is complex and ever changing, which has prompted many companies to enlist specialized expertise in this critical area. Here are some tips that offer a clear starting point for your worker classification practices.

 

1. Understand government guidelines (or at least try to). Various federal and state tests can be applied during an audit. Make sure to follow guidelines as completely and consistently as possible when engaging an independent contractor. Many of the documents and guidelines that agencies use when executing an audit are public information and can be found on their respective Web sites. However, these guidelines are often interdependent and can be confusing or ambiguous. Any question as to proper classification of a worker is best answered by a subject matter expert that understands how to apply the tests correctly.
2. Use independent contractors that have an established business. Engage contractors that perform services for multiple unrelated clients simultaneously. Identify and select independent contractors that have a documented history of providing services. Request licenses, references, marketing materials, proof of insurances and so forth that indicate an established business.
3. Use independent contractors that provide services not integral to your core business. Do not engage contractors to perform the same or similar services as your regular employees. Engaging contractors to perform the same positions or work functions as existing employees is indicative of staff augmentation, rather than a specialized, defined project for contract.
4. Create and execute appropriate contracts with each independent contractor for each engagement. Enter into a contractual agreement that clearly explains the intended relationship of the parties. It is best to have an expert review the contract for compliance with regulatory guidelines. Contracts should be constructed to describe a business-to-business engagement, and should not include employer-employee language that suggests governance or supervision. The contract should be accompanied by a comprehensive statement of work that outlines the deliverables and financial agreement. Non-disclosure agreements and other intellectual property protection should be included in the contract process.
5. Address worker classification for each and every project. Even independent contractors with a documented history of providing business-to-business services can be improperly classified based on the project scope and definition. Do not engage independent contractors for multiple years on a single project. This can be indicative of an employer-employee relationship or a regular position with the company. Projects that require direct supervision, mandatory work hours, on-site attendance or company-issued equipment can be problematic regardless of the independent contractor.
6. Maintain audit files to support classification decisions. All qualified independent contractor classifications should be supported through documentation of the evaluation process and the materials collected to support the classification. In the event of an audit, companies are accountable for producing the appropriate documentation to prove an independent contractor is properly classified.
7. Do not engage a former W-2 employee of your company on a 1099 basis. Companies commonly make the mistake of engaging a previous W-2 worker as an independent contractor. This poses risk since these individuals often return to perform the same or similar tasks as performed in their previous employee role. It is safest to engage an independent contractor that has an established business and performs services for multiple clients over time.
8. When in doubt, outsource! A comprehensive 1099 classification program requires resources and expertise that may not be resident within the company. The changing regulatory landscape, number of auditing agencies and new precedent-setting cases make 1099 compliance a difficult path to navigate. Outsourcing with 1099 compliance experts can provide counsel and education through the evaluation process, alternative employment options for non-qualified independent contractors and compliance confidence without the worry of risk.

Click here for a listing of the state tests used to classify workers.