The Federal government and the states recognize Independent Contractor (IC) as a legitimate worker classification. However, either knowingly or unknowingly, employers sometimes incorrectly misclassify workers as ICs instead of employees.
“Employee” is generally the default status the government assumes in ambiguous circumstances. Worker misclassification is an expensive and time-consuming mistake.
In the event of a government investigation, the employer client must prove that they have properly classified a worker as an IC. Government agencies use a variety of multi-factor “tests” to determine status.
While not specifically one of the factors, it is an advantage to the IC and the employer client that the IC is a bona fide business.
This alone does not determine classification; government agencies and courts “weigh” all the test factors. However, if the employer client and IC have compelling evidence that the IC is a bona fide business, that evidence will aid in supporting the IC status claim.
What is evidence of a business? The list below is a good start. The “stars” next to each item is the opinion of the author as to the importance of each item on a 5-Star Scale.
Type of Entity *
• The type of entity does not weigh greatly in determining IC status.
• LLC or S-Corp status may give more credibility to an IC claim than does a Sole Proprietorship. The main purpose of an LLC and S-Corp is to shield the individual from liability.
Business Cards *
• Provides some evidence of a business entity, but not much.
• Account in the name of the business is preferable.
• Some form of evidence that the business receives mail addressed to the business, at that address, such as phone bill, federal and state records such as tax returns, and other bills.
• This element earns 5-Stars if the ICs office is separate from a residence.
• Bank account in name of business, used only for business purpose.
• Avoid commingling business and personal funds and expenses.
Record Keeping and Accounting **
• Simple business bookkeeping and accounting system is sufficient.
• Maintain record of all employer client billing.
• Maintain record of all business income and expenses.
• Maintain record of hourly billing if that is how the service is billed.
• Print employer client bill on IC business invoice/stationery.
• Best if the IC bills a flat rate for the total job, stipulated in written agreement/contract. This practice also supports the claim of opportunity for profit or loss.
• However, billing on an hourly basis is acceptable.
• Evidence of a business specific investment used to advertise services to the public.
Written Agreement for Services **
• An essential document, but does not carry much weight to determine classification unless it stipulates that the IC has total control over services delivered.
Government Recognition ***
• Federal Registration/Tax ID: EIN
• State Registration/Tax ID
Licenses & Permits ***
• Business or Occupational License/Permit.
• Other licenses and permits, preferably in name of business when possible.
Specialized and Advanced Training ***
• Evidence of high level of skill or specialized skill, and training.
• This has less weight if the job only requires low-level of skill or the IC services are part of the employer client’s usual business.
Tax Filing Status ****
• Federal Tax Return such as Schedule C for sole proprietor and LLC, or Form 1120S for S-Corp.
• LLCs and S-Corps are pass-through entities for tax purposes; some states do not require a separate business tax return.
Worker Comp Insurance *****
• If an IC gets hurt, the IC can sue the employer client if the IC does not have WC insurance.
• IC should have its own WC insurance, especially if the IC has other employees.
General Liability Insurance *****
• IC should have GL insurance.
• Employer client has unlimited liability for claims caused by the IC if the IC is without GL insurance.
• An ICs GL insurance will reduce employer client liability exposure.
• Employer client will want to be named as additionally insured on the ICs GL insurance.
It is worth repeating that simply being a business is not enough to satisfy the worker classification tests, other factors have significantly more influence. Nevertheless,
• Smart employers will hire ICs that have evidence of “a business.”
• Smart ICs who want more business will have that evidence.
Michael Nossaman is PSC founder.
See related article Security Officers Are Not Independent Contractors Court Says
DISCLAIMER: THE INFORMATION PROVIDED HEREIN IS FOR GENERAL INFORMATIONAL PURPOSES ONLY. It does not constitute the provision of legal advice, tax advice, accounting services, or professional consulting of any kind. The information provided herein should not be used as a substitute for consultation with professional tax, accounting, legal or other professional advisers. Before making any decision or taking any action, you should consult a professional adviser who has been provided with all pertinent facts relevant to your particular situation.
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