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Businesses that hire independent contractors find it can bring intense regulatory scrutiny
It used to be that businesses could hire workers and classify them as independent contractors without giving it much thought.
Businesses presumed, for example, that if a worker called herself self-employed, provided some of the tools for the job, worked under an independent contractor agreement, and worked somewhat independently, then the independent contractor designation was a proper classification. It mattered little that this common understanding was substantially incomplete since proper independent contractor classification was not an enforcement priority.
The climate for hiring independent contractors has changed, however, and it has changed in a big way. With more and more businesses opting to classify workers as independent contractors — resulting in “lost” government revenues and worker complaints of misclassification and improper denial of benefits — federal and state governments have been moving aggressively to reign in the use of independent contractors. The result has been a climate that is intolerant of independent contractor misclassification, and inhospitable to the independent contractor business model.
First, states have enacted or amended independent contractor legislation to drastically narrow the class of service providers who can qualify as independent contractors. In Washington, for example, a business must be able to prove each element of the following test to establish that its service providers are independent contractors:
1. Contractor is free from control or direction;
2. The service is performed away from the company’s place of business;
3. The contractor is engaged in an independent trade, occupation, profession or business;
4. The contractor is responsible for filing taxes with the IRS;
5. The contractor has a business license and UBI number; and
6. The contractor maintains books and records of income and expenses.
Businesses must strictly comply. Failure to satisfy any one of these elements is alone sufficient to flunk the entire test, and subject businesses to significant fines and penalties for misclassification.
Second, cracking down on independent contractor misclassification has become a priority for both state and federal agencies. At the federal level, the IRS estimates that it has lost billions of dollars in tax revenues due to independent contractor misclassification, and has partnered with state revenue agencies to share information and enforcement techniques. Last year, the U.S. Department of Labor hired more investigators to “detect and deter” independent contractor misclassification, and initiated a misclassification initiative through which it partners with states to coordinate enforcement efforts. This year, the DOL has committed $14 million to combat misclassification.
On the state level, Washington has partnered with the DOL and IRS on their misclassification initiatives, and itself has a vibrant program to address misclassification. At a public hearing last month, Washington’s Department of Labor and Industries boasted that for every $1 it spends addressing the underground economy (which includes independent contractor misclassification), it recovers $9.30 in tax assessments; and for every targeted audit it conducts (which are the majority of its audits), it makes tax assessment in 76 percent of those audits.
Third, the independent contractor classification is being targeted by new legislation. Last month, a bill was introduced that would make sweeping changes to independent contractor law, including redefining the independent contractor definition to prevent more service providers from qualifying, and setting stiff penalties for misclassification ($1K-$10K per misclassified worker). Unions have identified this bill’s passage as their top legislative priority.
Fourth, workers are becoming educated about what it means to be an independent contractor, and they are questioning their classifications, reporting their companies to state and federal agencies, and initiating lawsuits (even class action lawsuits) for improper denial of benefits.
While it is certainly more risky to hire independent contractors, using independent contractors remains a viable and indispensable model for conducting business. What is clear, however, is that businesses cannot continue to hire independent contractors as usual, or to neglect strict legal requirements and best practices for managing independent contractor relationships. The cost of noncompliance is much too high.
Nigel Avilez is an attorney at Mercer Law PLLC on Mercer Island. The firm specializes in independent contractor/worker classification law and in representing businesses in independent contractor audits and appeals.