08/ 01/ 2004
by Gene Zaino
To many small to medium-sized businesses, independent contractor compliance issues often seem like “someone else’s problem.” When they see the government impose massive and well-publicized fines on corporate powerhouses like Microsoft and Time Warner, they commonly believe that regulations for using independent apply only to the bigger players.
Don’t believe it. Then IRS estimates that it loses over $2 billion each year in taxes not paid by independent workers. It is clearly motivated to make sure businesses—all businesses—only engage contractors who comply with the IRS’s requirements for independent contracting. The fewer non-compliant contractors out there, the better the likelihood that the IRS will plug the leak of lost tax revenue.
While understanding all the subtleties of contractor risk issues can be a challenge, there’s one underlying truism: Individuals who work as W-2 employees—from whom taxes are withheld automatically—incur less risk than “1099s” and sole-proprietors whose tax payments are not guaranteed. And while it is the individual contractors who are responsible for their tax payments, the IRS finds it more effective to pursue compliance at their client companies. If these clients only engage individuals who comply with the IRS’s guidelines for independent contracting, the contractors themselves will have no choice but to follow.
But how does the IRS decide this? The IRS determines a contractor’s compliance by looking at three “evidentiary areas of control.” These are behavioral control (whether the client dictates the way the contractor gets their work done), financial control (whether the contractor has risk of financial loss based on performance) and type of relationship (including whether the contractor works for multiple clients simultaneously). To make the matter more confounding, there’s no magic formula that determines contractor compliance. IRS auditors look at these and other factors and make judgments based on the evidence.
With 2 billion reasons to make sure contract workers are correctly classified, it’s no wonder that companies of all shapes and sizes lie in the crosshairs of IRS auditors. To understand the potential havoc that such an audit can wreak, consider that in 95 percent of the cases the IRS determines contractors should be reclassified as W-2 employees. And when that happens, look out: Penalties can include monetary fines, back-benefits costs and more. The effects, especially on smaller businesses, can be devastating.
Fortunately for businesses, you can take a major step towards compliance simply by making sure all of your contractors are W-2 employees. This doesn’t mean they have to be W-2 employees of your company (which of course would no longer make them contractors); instead, they can be W-2s of another company while they work on your contract.
Most commonly, this is achieved using staffing companies. Staffing companies help you find contractors for your assignments and then serve as their W-2 employer as they work. This achieves the IRS compliance you need, but the trade-off is cost: Staffing companies commonly mark-up their contractors’ hourly pay by 20 to 50 percent.
If you don’t need the recruiting services of a staffing company (i.e., you can fill your contract assignments on your own), a much less expensive option is to use an external contractor employment company, such as MyBizOffice. These companies provide the safe W-2 employment services you need for compliance without the overhead costs associated with recruiting. As a result, you can safely engage contractors as W-2 employees for as little as 4 percent over what you pay them.
Contractors who choose to remain independent aren’t necessarily precluded from working safely with your company, but they must be able to pass the IRS regulations discussed above. As a business owner, the decision is yours as to whether to engage such individuals, trusting their compliance status, or to find an equally qualified worker who will go W-2.
Considering the financial devastation that misclassified workers can bring, are you willing to risk it?
Gene Zaino is President and CEO of MyBizOffice, Inc., the leading provider of efficient employment services for independent individuals and the organizations that use them. He is a noted thought-leader in the contingent workforce space and is frequently quoted in national newspapers, magazines, and radio and television program. Reach him at gzaino@mybizoffice.com.
