Question the Status of Independent Contractors

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By doing so, you can help your organization avoid misclassifying workers and therefore avoid substantial liability.

Since the late 1980s, the IRS has increased its investigation and pursuit of employer misclassification of workers as independent contractors. Motivating the IRS crackdown is a 1989 report concluding that the federal government lost more than $1.6 billion annually because of misclassifications, and allegations that some contractors write off expenses that are not truly business-related.

An employer could operate for years with employees misclassified as independent contractors and never be questioned. That bliss, however, could end unexpectedly with an event as simple as the filing of an unemployment compensation claim by a worker. After the business denies that the worker is eligible for benefits (as it must, because no payroll taxes were paid), the unemployment compensation agency often holds a hearing to determine if the worker, under law, was an employee or an independent contractor.

If the worker is found to be an employee, an investigation often ensues to determine if the employer has misclassified others. Many state unemployment compensation agencies refer such employers to the IRS and to the state's workers' compensation agency for investigation.

An IRS investigation can begin with an audit of the business, an audit of a contractor, or the filing of an IRS Form SS-8 by a worker seeking an IRS determination of his or her status under the law. If the IRS finds the worker to be an employee misclassified as an independent contractor, it may notify the relevant state compensation agencies, who may then investigate. In short, the stakes can be high, and an investigation can rise up seemingly out of nowhere.

FOUR STEPS TO PREVENT MISCLASSIFICATIONS

If your organization uses independent contractors frequently, it should develop specific procedures to ensure that they are properly classified. Here are four steps that will help guide you toward proper classification.

1. Find out what is happening. First, find out how your organization is using independent contractors. In small organizations, this step may be unnecessary. In larger organizations, however, many managers retain independent contractors without consulting the human resource department. …