In these tough economic times, everyone is looking for creative ways to save money and if you’re a business leader one solution you may be considering is to reclassify current employees as independent contractors; or you may be considering hiring independent contractors instead of adding full time employees to your headcount. But classifying employees as independent contractors has never been riskier especially considering the DOL has partnered with the American Bar Association (ABA) to refer complainants to local attorney’s in your area for FLSA violations. So, what’s at stake and how do you protect yourself?

If the IRS, Department of Labor or a state agency determines that you’ve misclassified workers, the mistake can lead to tremendous liability. In addition to overtime, your former independent contractors may seek employee status to collect workers’ comp, health & welfare benefits, unemployment benefits or damages in a civil rights lawsuit. Consider the fact that AT&T, the telecommunications giant, is currently embroiled in a $1 BILLION wage & hour lawsuit for misclassifying their employees.

One of the biggest questions in determining if a worker is an employee or a contractor lies in how much control you, as the employer, have over the worker’s schedule, materials, behavior, risk level, etc. Job titles or labels don’t matter. If your worker looks like an employee and is paid like an employee, they’re probably an employee.

The last time the IRS studied misclassification, in 1984, it estimated that about 15% of employers nationally misclassified a total of 3.4 million employees as independent contractors. A 2005 government report said 10.3 million American workers—or about 7.4% of the workforce—were classified as independent contractors, and of those the IRS estimates that 80% are classified incorrectly.

To keep you and your company compliant you need to:

  • Follow the IRS guidelines to avoid unwanted scrutiny
  • Know if your state has more stringent definitions (Tennessee does!)
  • Use an independent contractor contract clearly outlining the working relationship
  • Be consistent on how you classify everyone in the same class of workers.
  • Send 1099s to all workers you paid more than $600 in the tax year
  • Have your accountant certify your worker classifications
  • Limit your interference – one of the best tests of an independent contractor has to do with control – how and when the independent contractor does their work, so keep your distance. The more control you exert, the more likely they’re really employees.

Stay tuned next week, when we talk about the 3 main categories of evidence the IRS uses to determine if a worker is really an independent contractor, including 10 questions that IRS auditors use to determine a worker’s status.