Attaining Independent Contractor Status

Businesses that hire employees are responsible for payroll taxes, employee benefits, and the related administration and compliance tasks arising when wages are paid to employees. Businesses generally do not have these responsibilities for independent contractors; they need only file a Form 1099-MISC for the payments they make to the contractor.

For some businesses, the reduction in human resource paperwork and compliance administration is sufficient motivation to have work performed by independent contractors. If potential payroll tax and employee benefit savings are also factored into the equation, it is easy to see why many businesses prefer to hire independent contractors for specialized tasks and jobs of relatively short duration.

In today’s economy, companies are looking for ways to reduce the cost of doing business. Understandably, the opportunity to cut total labor costs substantially often proves irresistible. Classifying a worker as an independent contractor can simply be too good to pass up. However, the IRS is concerned that some employers are classifying true employees as independent contractors merely to avoid payroll taxes. As the IRS continues its relentless assault on worker classification, it becomes increasingly important that businesses take precautionary steps to ensure compliance with all IRS requirements in order to avoid a costly reclassification of workers from independent contractor status to employee status.

Independent contractor status generally is available if the business meets the following requirements:

1. Files all information returns (i.e., Form 1099-MISC) for the workers or classes of workers at issue.

2. Has not and will not treat the workers at issue (or classes of workers in substantially similar job positions) as employees on income tax returns, payroll tax returns, or other returns filed by the business.

3. Has a reasonable basis for treating the workers as independent contractors. The law provides certain safe harbors to meet this requirement, or the business can rely on some other reasonable basis.

These requirements must be met each year. If the company fails to file Form 1099-MISC on a worker, it loses the independent contractor status for that worker for that year. More importantly, if the business fails to treat the workers (and workers in substantially similar job positions) as independent contractors during a particular year, it loses independent contractor status for the year of violation and subsequent years for the entire class. Thereafter, the company cannot obtain independent contractor status for that class of workers.

Changes in the business work environment, job positions, or the treatment of workers within particular classes may dramatically impact the business’s eligibility to classify workers as independent contractors.