Classify your workers properly, or else

By Randy Bonnecaze

As an employer, you must withhold federal income taxes, Social Security taxes and federal unemployment taxes from your employees' wages. You may also have to provide them with equal access to fringe benefits and retirement plan coverage.

But you don't have these obligations to workers classified as independent contractors. They typically receive a check for services rendered, along with a Form 1099 at year's end.

Improperly classifying actual employees as independent contractors can lead to a number of financial liabilities. These include owing payroll taxes, unemployment compensation, workers' compensation, employee benefits and overtime obligations, as well as having to pay employment discrimination fines.

Because construction companies frequently hire independent contractors, it's critical to ensure you're classifying these workers properly.

Learn the factors. Workers are generally employees for federal tax purposes if their employers control and direct the jobs they perform and how they perform them. The IRS has sought to streamline the process for determining worker status under "common law" factors developed through judicial decisions. It now groups the degree of control into three general categories of evidence:

• Behavioral control - the right to control and direct how work is done
  
• Financial control - the right to oversee the business aspects of workers' activities
  
• Affiliation - the type of relationship between the parties, including each side's intent and how they respectively perceive their relationship

Requiring on-premises work. This suggests control if workers perform their duties elsewhere. For example, work done at the independent contactor's office indicates greater freedom. The importance of this factor depends on the type of services involved and whether you would normally require employees to do similar work on your premises.

Offering facilities and equipment. Employees usually rely on their employers for things such as office space and tools. You may be able to more easily defend the status of independent contractors if they provide these items.

Providing "employee-like' compensation. Hourly, weekly or monthly payments typically point to an employer-employee relationshlp. To fortify independent contractor status, you're better off paying by the job or on a straight commission basis.

Assuming all of the risk. A given project's success or failure usually doesn't threaten employees' paychecks. Conversely, workers who can realize a profit or suffer a loss as a result of their services are usually deemed independent contractors.

Retaining the right of dismissal. If you may fire a worker, he or she is likely an employee. Independent contractors, on the other hand, geneally can't be dismissed as long as they produce the work under contract.

Establish the right procedures. Avoiding this semantic quagmire calls for establishing procedures that ensure you don't inadvertently misclassify any workers. A good place to start: Develop a checklist or questionnaire to gather facts about those you currently classify as independent contractors. Then compare these facts to the common law factors. At that point, you should know whether you're properly classifying the workers.

In addition, prepare a written agreement outlining your relationship with independent contractors and supporting their classification as such. Require that all independent contractors sign the agreement before starting work.

Also ask independent contractors for tangible evidence of their autonomy. Acquire copies of letterhead, invoices, logos, business cards and advertisements.

If they operate through their own corporations, record their federal employer identification numbers and equivalent state numbers. Mandate written proof that they've obtained or lawfully waived coverage under workers' compensation and unemployment compensation laws.

Stay wary. The question of whether a worker is an independent contractor or employee for federal income and employment tax purposes is a complex one. And answering it remains a significant source of conflict between the IRS and many businesses - including construction companies.

If you engage independent contractors, you must properly document your relationships with them and maintain records that support their employment classification. You should also periodically review the status of all of your workers, keeping in mind the control factors, to ensure you're not in danger of coming under IRS fire.

Editor's Note: Randy J. Bonnecaze is a Certified Public Accountant (CPA) with Hannis T. Bourgeois LLP, Baton Rouge.