Independent contractors: a definition

We've written a lot about independent contractors and more specifically, about the need for companies to look into their use of independent contractors. While there appears to be more focus on this than in the past, there is still some confusion around the definition of independent contractor and how their status is properly determined.

First, here's a definition in my own words:

Independent contractors (ICs) are individuals or small companies paid as a vendor by your company to perform work on or off-site, with minimal or no supervision from you or your managers. They are usually engaged to complete a defined task, series of tasks, or provide specific subject matter expertise. An independent contractor is not an employee, does not receive a paycheck or benefits, and is responsible for their own tax payments, insurance, and whether or not their business makes any money. They are sometimes referred to as "1099" workers, a reference to the IRS form used to report payments earned and paid to an IC.

So why all the confusion and risk related to who is an independent contractor and who isn't? Well, like so many things in life, it comes down to money. As I noted in my definition above, an independent contractor is responsible for paying taxes on his or her own. So the federal state, and local government sees no wage taxes. It's up to the independent contractor, as a business, to report and pay the appropriate taxes.

But an even bigger issue lies with companies that utilize ICs. There are fines and penalties for misclassifying someone as an IC, and it can have far-reaching effects on your benefits programs, especially since many ICs are highly compensated. If you are an HR professional, that last line should have made you cringe.

If you carefully read my definition above, you can pick out some of the big things that I believe really make a difference, but I think it's more fun to take the Jeff Foxworthy approach. So here are a few things that, instead of making you a redneck, might make you an "IC Violator" at risk for your use of independent contractors.

You might be an IC Violator if:

• The IC is doing the same or very similar work, under the same or similar conditions as a regular (W-2) employee.
• An IC works on-site, has a company badge, company desk, company phone, company computer, etc.
• Your manager gives the IC daily instructions and/or closely supervises his/her work.
• You pay the IC on contractual terms that don't include things like milestones, acceptance, required insurance or a warranty on the work.
• The IC does not have specific tasks to complete and is then expected to move on to other tasks or work for other customers.
• If you've never looked at your IC populations, their contracts and/or have no formal process for determining who is an IC.

At the end of the day, there's only one definition that really matters: the IRS definition. OK, maybe two: the IRS and your legal department. The IRS uses a series of questions and other newer factors such as the control and independence over behavior, finances, and benefits to determine the independent status of an IC worker versus an employee. They do give consideration to companies who try to do the right thing, and that's where your legal department comes in. Many studies show that a majority of independent contractors today are misclassified.

One final note: One thing that I believe we will see more of is ICs suing for benefits. These are workers who seemed happy as an IC, having no taxes taken out, but then realized that they still had to pay taxes later, and they got no benefits while doing the same job as the guy or gal in the cube sitting next to them (that's why the first one in my list above is so important).

So take the IC/Jeff Foxworthy test above, talk to legal and perhaps find a company that specializes in independent contractor evaluation services, sometimes referred to as "ICES." It's one sure way to prove you're smarter than a fifth grader.