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THE LAW. Many organizations don't think twice about using independent contractors. They're an attractive labor source because you don't have to shell out payroll taxes or benefits for them, nor are you typically liable for them under many federal employment laws.

But that relationship can come crashing down if the IRS or a disgruntled contractor ambushes you, claiming certain workers are truly "employees," not independent contractors.

So how do you make the right call? The IRS uses its infamous 20-factor test to differentiate employees from independent contractors.

The issue comes down to one word: control. The more control and supervision you exert over the workers' schedule and production, the more likely that the worker will be deemed a full-fledged "employee."

Basically, the law says your organization has the right to control the result of work done by independent contractors, not the means and methods of accomplishing that result.

Still, the IRS's 20 factors are rather subjective, which has created much confusion for employers, and lots of lawsuits. If your organization mistakenly classifies employees as contractors, it could find itself liable for back taxes, interest, penalties, unpaid overtime and lost Social Security benefits. The contractor-turned-employee may also earn rights under anti-discrimination laws, plus rights to file workers' comp or unemployment claims.

The IRS isn't the only enforcer. Some states place even more stringent definitions on independent contractor status. It's not unusual for a state unemployment compensation board and the IRS to disagree on a workers' classification. At least 22 states apply a stricter test to determine worker status.

WHAT'S NEW. Because the 20-factor test steadily lost ground in the courts, the IRS has applied a somewhat simpler version. It recasts the 20 questions, setting forth three main guidelines:

1. How much behavioral control does the employer exercise over the worker?

2. What financial control does the employer have over the worker?

3. How do the worker and employer view their work arrangement?

Also, courts today are looking beyond labels and contracts when deciding worker classification. Signed agreements that attest to independent contractor status are no longer enough. Courts focus on the actual relationship, including the worker's opportunity for profit and loss.

HOW TO COMPLY. To make sure the IRS or another agency won't swoop down and change your contractors' status, or that a contractor will claim he or she is truly an employee, follow these five preventative measures:

1. Enforce the classification rules consistently. Make sure you categorize similar employees in the same class of workers, and send 1099s to all contractors to whom you paid more than $600 in the tax year.

2. Re-examine your benefits policy. In your benefits plan information, make sure to explicitly exclude contingent workers. Have contractors acknowledge in writing that they aren't covered.

3. Have an accountant certify your worker classifications. Obtain a letter from your accountant affirming your workers' status. That document helps demonstrate that you made a good-faith effort to comply with the law.

4. Sign a contract. While contracts won't offer total protection, they may deter a lawsuit, plus they can reduce the odds that you'll face tax penalties when the IRS comes calling. The contract should describe the work to be performed, how much you will pay, the length of the agreement, the project's deadlines and a statement that no benefits will be provided.

5. Keep your distance. Don't try to overly control how and when the contractor carries out his or her duties.? Free reports:

Sample independent contractor's agreement

You & the Law offers two free reports on this topic at our Extra! site, www.you-and-the-law.com/extra:

 

  • Independent Contractors: The Legal Boundaries provides classification advice, plus a sample in-dependent contractor's agreement you adapt for your organization.

     

     

  • Independent Contractor or Employee? How to Make the Call details the 20-point IRS determination test.

 

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