Independent Contractor Classifications

Friday, March 11, 2011

With the Department of Labor’s (DOL) plans to expand their “efforts to deter and detect worker misclassification”, it becomes even more important for organizations to review their use of independent contractors. To be effective, this undertaking should be a prospective rather than a retrospective process.

Key to this review process is analyzing the guidelines the IRS uses to determine whether a worker is a statutory employee or an independent contractor. These guidelines start from the presumption that the worker under review is in fact, a statutory employee and not an independent contractor. The IRS guidelines address three central areas of control: Behavioral and Financial controls, and Type of relationship.

Behavioral control deals with the who, what, when, where, and how the work is performed. Financial control addresses issues on how supplies and equipment are purchased, how the contractor is compensated, and the degree to which the contractor is exposed to financial risk. Type of relationship is focused on the presence of written contracts, whether the contractor has access to certain employee-type benefits, how permanent the relationship is, and are the services performed those of the contracting company? While the IRS will place a significant degree of weight on the above, they will look at other factors as required.

Behavioral control focuses on the who, what, when, where, and how of the, however, this is often described in some detail within a “Scope of Services” or similar document(s). This document may contain technical drawings, work and materials specifications, timetables, compliance or building codes, and access requirements. Nevertheless, such documents should not dictate that a specific worker perform a specific task, although, the organization can certainly require that a person performing the work meet certain technical specifications, licensing or credentialing requirements. Depending on the nature of the work, the independent contractor may be required to perform all work onsite due to security or access control reasons.

Financial control addresses how supplies and equipment are purchased, compensation for the work, and the whether there is exposure to financial risk by the contractor. By reviewing the financial aspects of the work, the DOL or IRS can ascertain the degree of independence between the parties. A large expenditure by the contractor on separate facilities, supplies, tools, and equipment supports the independence of the contractor. If the contractor is paid, only once the work is complete and the work passes all required testing, certifications, and regulatory barriers; that reinforces the position of independence. If the work agreement contains provisions for late or performance penalties, again that reinforces the position of an independent contractor.

Type of relationship is focused on the business independence of the parties. Are there written contracts, how extensive are they, how well do they describe the work to be performed, were they approved by the organization’s owners or management? Who provides employee-type benefits to the persons performing the work? How permanent is the relationship between the parties? What businesses are the parties in and are they the same or similar businesses? How are the parties organized, are they single proprietors, partnerships, corporations, are they licensed and recognized as independent businesses by local, state, or federal regulatory bodies?

Organizations by asking these questions upfront, organizations can go a long way in ensuring their ability to meet and exceed to audit challenges raised by either the DOL or IRS.

As with any relationship with local, state or federal rules and regulations, organizations should seek credentialed professional advice and assistance from a credentialed professional legal counsel.