July 2002

Are You Really an Independent Contractor?
By Deb McClanahan

We all think of ourselves as purely Independent Contractors (IC's) or Consultants because we run our own businesses and consult with multiple clients. But, the IRS recently changed the rules of the game, quietly replacing its decades-old objective "20 Question Test" with a more vague approach that includes three categories with some level of confusion possible in each.

You may find your clients asking you for new documents, preparing more complete files on you, signing new contracts, or demanding that they payroll you as a temporary employee. We don't want our clients to be non-compliant, nor do we want them to pay payroll taxes on us or have payroll taxes withheld from our earnings. These, of course, are only part of the background of why we want to maintain legal Independent Contractor status.

For some introductory info on this topic, I'll review the 3 categories and refer you to a terrific, objective source for more information. If you find any or all of this confusing, don't be surprised. In all likelihood, your clients are probably also confused. If they need help on the subject, I'm happy to share some "complete IC compliance" solutions as well. The 3 new categories are:

Behavioral control
This category asks basically is your behavior controlled by the company? Do you receive training and instructions from the company? Do you receive specific direction on how to do your work? This is the scariest to me as an IC, because we all receive some level of advice from our clients on their requirements.

Financial control
Do you have significant financial investment? Are you paid by the job or the hour?
Do you have the opportunity to control profit and loss on the work? Do you have legitimate business expenses? Do you own the tools and equipment? Are your services offered to the general public? This category includes some of the previous 20 questions, and is relatively easy to demonstrate.

Catch-all Category: Type of Business Relationship
Are you liable for breach of contract? Are (employee) benefits provided to you? Does the contract have a termination clause? What is the intent of the parties? Does the work fall within the scope of the company's core business? This category has a good deal of room for interpretation, and may cause your clients some grief as well.
There is plenty of work in this material for the attorneys, and much risk for our clients, based on the huge settlement and attorney fees awarded in Vizcaino vs. Microsoft. This landmark case put all US companies on notice that using a third party payroll service may not protect a company from co-employment risk and benefit implications (particularly stock options) when using IC's. You as an IC don't want to be the cause of an audit of your client by either EDD or the IRS. Some of the simple actions that can trigger an audit :

• An IC files for Unemployment Compensation
• An IC is injured on a client site, and a Workers' Compensation claim is generated

While it may seem common sense that neither of these actions should ever happen, they do.

Another mechanism that can trip up your clients is the routine audit. EDD typically performs these.

The trigger may be a disgruntled IC whose contract was ended. Another trigger is the issuance of a 1099 and W-2 in the same year (whether from the same company or not). EDD also has a new requirement (intended to catch "deadbeat dads") that companies report any new IC within 20 days of the start of contract.

Over 1/3 of companies that are audited for IC's fail, and fully 50% of their IC's are re-classified as employees as a result. Think your clients aren't at risk? Think again. The risk they run includes paying payroll taxes on you and fines and penalties. So be proactive in thinking through the questions that your clients may be asking you soon. For more information on this topic, look at www.contingentlaw.com .This site provides a rich information source for you and your confused clients.

About the Author
Deb McClanahan is the principal of BroadBand HR Consulting, providing a range of strategic and tactical Human Capital services to small to mid-sized high tech and bio tech companies. She has been the provider of HR services to young and growing organizations. Deb's career spans several decades and includes HR, Manufacturing Management and Business Process Analysis and Planning. Among the companies that she is currently advising is ComplianceServer, which is the first company to automate contingent workforce management compliance. Email her at: Debmack@aol.com