Audit Your Independent Contractor Classifications Before the DOL Does

We recently attended a business workshop and in the section on hiring employees, a business owner asked a question. He started out by saying, “I hired a 1099 employee…” 

That's all I had to hear to know that he was not in compliance with hiring employees and independent contractors. In case you're not sure why, there is no such thing as a “1099 employee”. They're either an employee or an independent contractor who receives a 1099 instead of a W-2 each year.

I was surprised because he runs a company that does well over $1 mil in sales, so it's not just the small companies that don't fully understand employment laws. If I were him, I'd consider auditing my independent contractor classifications as soon as possible.

Is it time to audit your independent contractor classifications?

Why You Should Be Concerned about Independent Contractor Classifications

The U.S. Department of Labor (DOL), wants to convert as many independent contractors as possible to employees because it increases employee tax revenue. They are actively working with the IRS, sharing information to find companies with red flags – signals that they could be out of compliance and ripe for an audit.

What are the red flags?

These are just a few of the red flags that can alert the DOL to possible worker misclassification:

• An “independent contractor” files an unemployment claim (this is what happened to us)
• The DOL receives an anonymous tip (could be from a disgruntled “independent contractor” or a competitor who knows what's really going on)
• The independent contractor reports only one income with the 1099 you issued (if they are a true independent contractor they should have multiple clients issuing 1099's)
• The independent contractor does not have an EIN

What happens if the DOL decides to audit your company?

When the DOL decides to audit your company, they'll want to see your finances, payroll records, 1099 records and your operating practices. If this happens to you, chances are you'll end up paying a lot of money in back pay and fines. And depending on how long it's been going on, it could put you right out of business. It's also important to note that the DOL rarely loses a case against a company that misclassifies employees as independent contractors.

Luckily for us, it happened early in our business (in the 1980's), just 3 months after “hiring” our first subcontractors. We were naïve like many business owners and mistakenly thought that we could save money on employment taxes and the hassle of setting up everything you need to do to pay employees. Simple is better, right? Wrong…

At the time, we didn't have the luxury of the Internet to research and do our due-diligence. We just had a book from the state on starting a business, and some of the information around this topic was vague. But as I've said many times to business owners – the government doesn't give a break for ignorance of the law.

The result for us is that we had some back pay and fines, which amounted to about $3,000. It was a lot of money at the time, but now I realize just how lucky we were that they found out so quickly.

How to Audit Your Independent Contractor Classifications

The first step to truly protecting your company is to hire an experienced employment law attorney to do an FSLA Classification Audit. You'll be better off having your attorney identify potential problems before it escalates to the DOL. Your attorney will likely start by reviewing your Independent Contractor Agreements.

Your agreements should include several points that establish that you have a true independent contractor relationship. This list is a guide – be sure to consult with your attorney for everything needed for your independent contractor agreement.

• Include a statement that your company lacks control over the means by which the worker performs his or her duties. You cannot provide training on how you want them to complete the cleaning, however you can control the schedule of the work depending on the agreement you have with the client (ie: the work must be performed between the hours of 6pm – 11pm).
• The worker uses his or her own equipment and tools (you cannot provide vacuum cleaners, mops, dusters, cleaning chemicals, etc)
• The worker can perform this work for other companies (you cannot limit them to working just for you, they should have multiple customers)
• The worker has his or her own EIN number
• The worker will provide invoices for the work provided to your company
• The worker can assign the work to others
• The worker must provide his or her own liability insurance, worker's compensation insurance and benefits
• The worker may make a profit or suffer a loss while performing for each project
• The relationship is on a temporary/project basis

In addition, here are a few “don'ts” when it comes to independent contractors:

• Don't give them a job description
• Don't pay them on an hourly basis (they should be invoicing you for the project, similar to how you invoice your clients)
• Don't pay mileage or give them access to company vehicles
• Don't give them business cards, computers, cell phones

If any part of this article has raised a red flag for you or raised the hairs on the back of you head; chances are you are not in compliance and should seek out Counsel immediately. I would rather see you be proactive and prepared when the DOL comes calling, instead of ignoring the red flags and putting your company at risk. Better yet, I'd rather see you head off an audit altogether by being a responsible business owner that cares about doing the right thing.

Do you have questions on this or other HR Compliance issues?

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