Sacramento Businesses Using Independent Contractors can Avoid Penalties for Misclassifying an Actual Employee

May 16, 2011

The use of independent contractors in the Sacramento area has grown dramatically over the past decade. Many businesses rely on independent contractors to supplement their workforce and to provide specialized services. Much to the woe of Sacramento businesses, the classification of workers as independent contractors has come under increased scrutiny by both federal and state governments. In the Fall of 2010, The United States Department of Labor published an agenda outlining a plan to work with the IRS to crack down on misclassified employees. Just recently, legislation was introduced in Congress on the issue of misclassification.

The Payroll Fraud Prevention Act (S. 770), introduced to Congress on April 8, 2011 is now in committee. This bill, if enacted, would expand the federal Fair Labor Standards Act (which currently addresses minimum wage, overtime, and child labor laws) to cover misclassification of employees as independent contractors. It would create a new definition of workers called "non-employees," impose upon businesses the obligation to provide a classification notice for both "non-employees" and "employees," make the misclassification of "employees" as "non-employees" a new labor law offense, and expose businesses to fines of up to $5,000 per worker for each violation of the law.

Despite that the laws are complex and multiple government agencies are involved, Sacramento businesses can avoid mistakes in this area. The IRS uses 20 highly subjective guidelines to determine whether the person is an employee or independent contractor.

Here are some biggies that a business should follow:

• If the company gives instructions on how to the work is to be done, the individual is an employee. An independent contractor decides how to do the work.
• An individual who already has the necessary skills and training is an independent contractor. If the individual needs training, they are an employee.
• Does the individual do work for more than one company? If not, this person appears to be an employee. An individual with multiple customers or clients looks more like an independent contractor.
• Does the individual work on the business premises? An individual who always works at the company's location looks more like an employee while an individual who works elsewhere looks more like an independent contractor.
• An individual who works on the company's normal day-to-day business looks more like an employee whereas an individual who works on occasional special projects looks more like an independent contractor.
• An individual who is paid a fixed fee for a defined scope of work looks more like an independent contractor than an individual who is paid hourly.
• An individual who is working under an appropriately drafted agreement looks more like an independent contractor while an individual without an agreement looks more like an employee.
• Businesses should further protect their position that an individual in an independent contractor by doing the following:
  1. Put your agreement with the independent contractor in writing. Include a description of the project, the expected duration, the amount to be paid and how it is to be paid, a paragraph specifically acknowledging that the worker is an independent contractor, and as many other details as can be agreed on. Specify that the worker must supply his own insurances. Ask for the insurance certificates and keep them on file.
  2. Get a completed I-9 form from the person and be prepared to issue a 1099 at year's end.
  3. Save any promotional materials or proposals that the contractor gave you. Also save the promotional materials from other contractors competing for your work.
  4. Pay only on invoices submitted to you by the contractor.
  5. If at all possible, do not pay on an hourly basis. You may have to, but if possible break down the amounts to be paid based on deliverables throughout the life of the project. You may pay periodic draws to aid the contractor's cash flow, but make sure the contractor accounts for them on his bills as draws against his billing for the deliverables.
  6. If the project runs over the original budget and the original contract terms, address this issue in writing. If you're prepared to pay the extra fees, add a contract addendum to cover it. If the project scope changes and you require additional work, add a contract addendum for that as well.