For many companies, business slows down in December, and the month becomes a time of planning for the next year. For companies who rely upon independent contractors, this would be a great time to assess the independent contractor business model and make improvements.
After years of outsourcing some or all of their operations to independent contractors, Colorado businesses are now receiving retroactive payroll tax bills after failing federal and state audits of their independent contractor systems. In other words, the auditors ended up reclassifying the independent contractors as employees. Then, they restated the Form 1099 payments as wages, computed the payroll taxes due on those wages, and issued a tax bill for the unpaid taxes.
Make no mistake about it. Companies can continue to use independent contractors -- and there are significant advantages on both sides to the business model -- but it certainly would be a good idea to learn what tests the auditors are employing during these audits to determine that a worker actually is an employee, not an independent contractor. And, of course, to assess how the company would do on those tests. And, even more important, to identify prudent changes to the company's contracting procedures that could be made to minimize the risk of failing an upcoming audit.
In previous blogs I've written about the "right to control" the way a worker gets the job done. That's the first test. As FedEx's experience shows, the more the company dictates how a job gets done, the more control it has. The more control, the more likely it is that an auditor or court will conclude the worker is an employee.
Colorado's law also requires that an independent contractor be "customarily engaged in an independent trade, occupation, profession, or business" related to the service they perform for the company under audit. That's the second test.
So, how does a company satisfy the "customarily engaged" test?
Based on my firm's experience, it's helpful, but not enough, that the independent contractors had organized their own LLCs or corporations or had adopted trade names.
So what is enough? Colorado auditors expect a business under audit to be able to demonstrate that each independent contractor it utilizes customarily provides similar services to the general public. Based on our experience, there are a couple of ways to do this. One is to demonstrate that each independent contractor works for other companies at the same time he or she works for the business under audit. Here are two more questions to reflect on this month: Just how would your business go about demonstrating that your independent contractors provide similar services to the general public? And, would your company be okay with your independent contractors providing identical services to your competitors?