Deseret News Archives,
Sunday, January 6, 2002

Edition: All
Section: Money
Page: M01
Length: 77 lines

Be wary about worker category

The technique is not new. And while it may save a few dollars in state and federal taxes, the consequences can be devastating if it isn't handled properly.

As I started my first real business, I considered all my employees to be independent contractors. After all, they didn't pay much attention to my efforts to manage them, and turnover was rapid. I barely knew what I was doing, so I spent little time training -- hence, the turnover.

Since salary was a major expense category in my operating budget, I felt the 7 percent savings I could accrue by classifying my employees as independent contractors was worthwhile. Those who worked for me didn't mind, since the arrangement allowed them more take-home pay.

I owned a franchise at the time, and although I was advised against the practice by the franchiser, I felt justified in taking that approach -- until one of my "independent contractors" threatened to report me to the IRS. Seems her accountant told her about the additional financial responsibility she had to assume for her own taxes as a result of my decision. Because I classified her as an independent contractor, she was obligated to pay that 7 percent in taxes herself.

For some reason, she didn't like that idea. Can you imagine that? Faced with interest charges, fines and penalties that amounted to many times the 7 percent I had been saving, I backtracked. I classified my employees as employees and quickly came into compliance with all of the laws and regulations regarding employee taxes and benefits. I haven't tried the "independent contractor" technique since.

The IRS is well aware of the potential for abuse of the rules regarding independent contractors. Consequently, it has published a 20--question guide to help employers decide if their workers should be designated as employees or independent contractors.

The more I learn about the "independent contractor" rules, the more I'm inclined to urge aspiring entrepreneurs to step very carefully around this potentially sticky issue.

Should a state auditor investigate your business and reclassify your "independent contractors" as employees, your problems have only begun. The IRS could come knocking next. Then the Labor Department could tally up all the overtime charges that you may owe (while you can pay independent contractors whatever you wish, there are regulations regarding the payment of employees that must be followed -- including overtime requirements).

If you have more than 19 employees, new avenues of regulation may follow, including requirements regarding the disabled, alien workers and a host of other federal and state laws. And in some parts of the United States, there may be efforts to unionize your operation, not to mention required maternity leave and enforced child-care requirements.

Reclassification of independent contractors as employees by local, state or federal government officials will also open worker compensation insurance issues, errors and omission insurance and potential litigation from former workers.

Business owners can avoid many complications by using an independent contractor agreement. In close cases, a well--drafted IC agreement can be the difference between winning and losing an IRS or state employment tax audit. However, you should keep in mind this bit of counsel from an attorney friend of mine: "Even a well--drafted independent contractor agreement will not turn an employee into an independent contractor."

If your particular industry has traditionally used independent contractors, such as in the field of real estate, recent federal legislative changes may make the case for independent contractors more compelling. Check with your accountant.

And by all means, get that brochure from the IRS. Contact them before one of your "independent contractors" contacts them for you.

Stephen W. Gibson is associated with the BYU Center for Entrepreneurship. He can be reached via e-mail at cfe@byu.edu.

© 2001 Deseret News Publishing Co.