Navigating The 1099 Independent Contractor Compliance Landscape

Written by admin on May 16th, 2011

will challenge any company’s efforts to comply with proper worker classification legislations, what happened to FedEx and Microsoft were just sneak peeks of a potential upsurge on these cases that may come in view of the expected .58 trillion dollars budget deficit of the US government for the year 2009.

How can you protect your business?

It is true that, no matter how much you comply, it is still possible that someone or somebody will challenge you for a variety of reasons – trivial or otherwise.  Even the experts believe that the issues on worker misclassification will continue to exist not necessarily due to employers’ misgivings but also because of the changing legislations concerning the matter which opens new avenues for debates.  Be that as it may, the sure thing is that there will continue to be a need for careful and factual interpretations of these laws and their impact to the business.

Today, a lot of employers have limited appreciation of what processes do they have in place for properly classifying their workers, or how their current independent contractors are providing services to their company.  The first thing they needed to do to review their existing policies for worker classification.  While their staff may be able to follow what is already written on the policy manuals, interpreting the ambiguities of various legislations for worker classification is usually not these companies’ core competencies which open the door for potentials risks to happen.

The IRS has Section 530 Relief Requirements for those employers who engage independent contractors’ services.  Obviously, the burden of proof rests on the employers to support their qualifications to avail of the relief under Section 530.  Taking into consideration the broad interpretations on each of the three (3) requirement areas, even an employer who complied having “Reasonable Basis” can still fail under Substantive Consistency or Reporting Consistency.  The margin of error is too narrow to allow for uninformed decisions on the part of the employers.  There can be so much at stake for too little to make as benefits for taking the risks.  You must always refer back to the courts’ notion about the “duck.”

We can lay down a few steps for companies like yours to consider in regards to employing independent contractors in your organization:

Be sure to apply appropriate government guidelines. Many federal and state agencies provide basic tests that are applied during a tax audit.  Follow the guidelines as completely as you can when engaging independent contractors in your organizations.  A lot of these audit guidelines are public information and may be found on the agency’s website.  But be careful about the making ambiguous interpretations, and be sure to ask or qualify your interpretations as necessary.
Only use independent contractors with an established business already. Select independent contractors who have a good list of multiple clients serviced over the years, and which can be verified or validated.  Require your prospective independent contractors to present supporting documents such as client references, professional licenses, marketing materials, and proof of insurance before signing them up for services you require.
As possible, only use independent contractors who provide services which are not integral to your core business. Never engage independent contractors for services that are similarly performed by your regular employees.  Doing so will be indicative of staff augmentation instead of a defined project allowed for contracting.
Be sure to create and execute proper contracts with each independent contractor for each engagement. Make sure that the contractual agreement you sign with an independent contractor clearly defines the relationship of both parties to each other.  Engage the services of an expert to review your contracts to ensure that you are compliant to federal and state government guidelines.  Remember that each state may have varying guidelines that you need to comply with.  It must be that your contract presents a business-to-business transaction and veer away from any employer-employee language that hints about supervision or management of the worker.  The contract must include a Statement of Work that details the contractor’s actual deliverables (work output) and subject to acceptance by your company.  You should also include Non-Disclosure Agreements in contracting, and the standard provisions about Intellectual Property Protection on the contract itself.
So as not to lose track of compliance, be sure to address worker classification for all projects that you do. Be mindful that even while you deal with a real independent contractor, your compliance can be diminished due to the ambiguity of your project scope and definitions.  To remedy this, having an expert eye to review your documents can save you all the trouble in the near future.  Problems may not happen now, but it does not mean they will not happen at all if you miss out on current compliance requirements.
Always maintain audit files / records as references to support your worker classification decisions. In classifying workers as independent contractors, be sure to support this with as much documentation that you can have – from evaluation of competencies, customer references, proof of concept, etc.  With the process in place, you can be well prepared to support your worker classification decisions in case of an audit.  The more supporting documentation and processes you have, the more credibility you have in the eyes of the auditors.
Make it a rule never to engage a former W2 employee of your company as a 1099 independent contractor. This is the most common mistake committed by a lot of companies today.  This is highly risky because more often than not, these workers are re-engaged to perform similar work that they used to do as W2 employees.  It will for your best interest to instead engage a real independent contractor with excellent track record of delivering your required services.  The difference can save you the trouble supporting your worker classification decisions during an audit later on.
Explore about outsourcing your compliance assistance. Ensuring defensible compliance to 1099 independent contractor legislations require resources and strong expertise.  The ever changing legislations both on federal and state levels continue to pose challenges for companies to ensure a worry-free path to compliance.  Engaging the help of experts improves your confidence on compliance and weed out potential risks.  Further, where an independent contractor engagement is not feasible, there may still be other means to acquire the talents you require for your projects minus the compliance risks.
Be a good citizen of the country, and make no compromise about it. This country has offered your company great opportunities to do business and improve the lives of those who work with you.  Be a model citizen and pay your taxes honestly.  Cutting corners to save thousands or millions may actually cost you three-folds or more in the near future.  And being a good American is your best contribution to our industry and our society at large.

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