Are Your "Independent
Contractors" Really Employees?
Independent contractors who are
engaged by an employer for an extended period of time may be treated as
employees for tax and benefits purposes. Whether these workers are freelance
creatives or employees obtained through a temporary employment agency, if they
render services for a single employer at the employer’s place of business
under its direct supervision, they will probably be employees, not independent
contractors. This conclusion will follow even if the "independent
contractor" has entered into an agreement with the employer or the
employment agency providing that the individual is not an employee. Under
these circumstances, the Internal Revenue Service would very likely determine on
audit that such workers are "common law employees."
The consequences to the employer
of reclassifying independent contractors as common law employees include:
1. The employer will be
responsible for one-half of the Social Security taxes payable with respect
to the employee’s "wages." This tax is in two components, and
the employer’s portion for old age, survivors and disability insurance is
6.2% of compensation up to the annual wage base. The employer’s share of
hospital insurance (medicare) is 1.45% of all wages paid.
2. The employer will be
responsible for Federal unemployment tax with respect to wages paid to the
employee.
3. The employer will be
responsible for any failure to deduct income tax withholding from the
employee’s compensation. Retroactive assessment of this liability may be
mitigated if the employee has properly reported the income for tax purposes.
4. The employer may be liable
for any benefits payable to "employees" that were denied to the
reclassified employee while he was treated as an independent contractor.
These benefits would include retirement plan participation and any group
health benefits. Particularly on a retroactive basis, these liabilities can
be substantial.
The possible responses to a
situation in which an employer has "independent contractors" who are
really employees include the following:
(a) Reclassify the workers
in question as employees for purposes of internal payroll and benefits as
well as tax reporting. This will entail, among other things, the reporting
of worker compensation on IRS Form W-2 rather than IRS Form 1099. Also
negotiate a reduction in cash compensation to pay for benefits, if
appropriate. This approach will not affect any liability for past conduct,
but should eliminate the employer’s exposure for future taxes and
benefits.
(b) Enter into specific
agreements that make it clear that the "independent contractor"
intends to be treated as an independent contractor for all purposes. This
document would include an acknowledgment that the worker has voluntarily
elected to forego certain employee benefits and assurances that the worker
will properly discharge his tax liabilities as an independent contractor.
The agreement should also contain an indemnity running to the employer to
protect it from the liabilities enumerated above, to the extent possible.
Note that these agreements will not influence the outcome of an IRS audit
except possibly in borderline cases. Also, because of the substantial
dollar amounts of potential employer liability, the indemnity agreements,
even if enforced by a court, may not provide reliable protection.
(c) Make sure the benefit
plans which exclude the independent contractors very clearly provide that
the exclusion will apply even if the workers are reclassified as
employees. For example, a profit sharing plan could, within the limits of
the coverage rules, be amended to expressly exclude from coverage any
independent contractor who has been reclassified as a common law employee.
This approach can help isolate the benefit exposure from the tax exposure.
(d) Invoke the IRS
administrative procedure for arriving at a settlement of back tax
liabilities. Although this approach may result in a better settlement than
an audit, a voluntary settlement with the IRS will eliminate the chance of
avoiding liability entirely by playing "audit roulette" (that
is, doing nothing in hopes that the applicable limitations period expires
before there is an IRS audit).
Andrew S. Williams
Aronberg Goldgehn Davis & Garmisa
One IBM Plaza, Suite 3000
Chicago, Illinois 60611
312/755-3145
awilliams@agdglaw.com
|