Independent contractor compliance doesn’t solely depend on what you, as a business owner, do to comply with independent contractor law. Indeed, you can have the best of processes and practices in place, but if your contractors fall short in operating as legitimate independent businesses (i.e. with those matters exclusively within their control), then your business will be found to be in violation of IC laws, and hefty back taxes and penalties for the contractor’s deficiencies will be assessed against you.
Below is a list of the top five ways – in no particular order – your contractors can sabotage your business, and presumably not intentionally so.
1. Allowing Licenses to Lapse. It’s not enough for a contractor to have the relevant business and contractor licenses. More importantly, the licenses need to be active, in good standing, and appropriate for the business the contractor is engaged in. Often I will have clients who have assumed that their contractors are properly licensed only to find out in audit that the license is lapsed, suspended, or otherwise no longer valid. When this happens, there is no fix, and the contractor will be determined to be a “covered worker” on whom taxes should have been paid.
- Best Practice: Ensure that your compliance checks and processes include checks with the Secretary of State and with the Department of Revenue and Department of Labor and Industries. LNI has a useful contractor verification tool for exactly this purpose.
2. Referring to Your Business as Their “Employer.” While contractors may not think of themselves as employees, it is not uncommon for them, when asked, to provide the name of a business they provide contract services to as their Employer. Word mean things, and this is just as damaging as referring to themselves as your employee. Consider this: A common trigger for an audit of a business occurs when a contractor is hurt on the job and has to seek medical treatment. When seeking treatment, the contractor is asked if it was a work-related injury, and then to identify their “Employer.” The contractor will understand/interpret “Employer” to mean the business for whom the services were being performed at the time the injury occurred. And just like that, the contractor will be treated as an employee, a claim for L&I benefits will then be filed, which is then followed by an L&I investigation into why the identified “Employer” was not paying workers comp premiums on a supposed employee.
- Best Practice: As much as you can, make clear to your contract partners not only that they are not your employees, but that you are not their employer, and to not identify you as such. Having said that, however, if it is the case that you have to explain to an independent contractor that you are not his or her employer, then there is a good chance that that worker is not a bona fide independent contractor.
3. Failing to Operate out of a Proper Office Space. To establish independent contractor status, a contractor needs to show that he or she is operating a legitimate business. One of the ways agencies test if a contractor has a legitimate business is if the contractor has an office. A traditional office space outside of the home is often a slam dunk indication that a contractor is running a legitimate business. A home office can also work, however. The office does not need to be elaborate, but it needs to be an office where business records are kept, and from which administrative activities of the business, at least, can be conducted. Auditors will often find that a contractor isn’t operating a legitimate business if the auditor learns that the contractor runs his business from a laptop on the living room couch.
- Best Practice: Do what you can to find out about your contractor’s home office space. Climb a tree outside his or her house and take photos for your file. I kid, though L&I actually recommends that businesses ask their contractors for photos of their office space. If you’re uncomfortable with L&I’s suggestion, you may consider just asking the contractor about their office space. While you’re at it, ask them if they claim a home office business deduction for their office (which is even better for your compliance purposes). This is all terribly invasive and antithetical to the notion of dealing with independent businesses, I know, but such is the state, and glaring contradiction, of our contractor law.
4. Failing to Show the Indicia of Operating an Actual Business. This failure can be manifested in several harmful ways (this sub-list approach is cheating, I know):
Failing to provide invoices for services rendered. Businesses invoice clients. A contractor who doesn’t submit invoices to you in order to receive payment will not be considered to be operating as a legitimate independent business.
- Best Practice: Pay contractors based on invoices prepared by the contractor on contractor’s business’s letterhead.
Having you as their only client. As stated above, independent contractors must be operating independent businesses. A contractor who works only for you will not be viewed by agencies as operating independent businesses.
- Best Practice: Inquire about your contractor’s other clients, and if they work only for you, expect that an auditor find that the worker is not independently established.
Failing to file taxes. Legitimate businesses file taxes. They may do so grudgingly, but they file taxes. During audits, auditors will contact independent contractors to determine whether they filed federal taxes (this inquiry is relevant to several parts of the independent contractor assessment), and an independent contractor who hasn’t file his or her taxes will be deemed to have failed the IC test.
- Best Practice: Include a provision in your independent contractor agreement confirming that the contractor is responsible for filing his or her own taxes. L&I recommends that you ask your contractor – your independent contractor, mind you – to supply redacted copies of their filed tax returns. You can and should try, but good luck with that.
5. Failing to Properly Answer Independent Contractor Questionnaires. As part of an audit, auditors will send out questionnaires to contractors inquiring into their independent contractor status and their dealings with the company being audited. The auditor will use responses from contractors to draw conclusions about the workers’ true independent contractor status. These responses can result in the business failing the independent contractor test, and if the contractor is truthful (as he or she should be), then the business should fail the test. Sometimes , however, the contractor may misunderstand questions and provide responses that are not reflective of the company’s operations, and which end up harming the business. Another way the contractor can harm the business is by not responding to the questionnaire. Auditors will find that your business fails the IC test if contractors don’t return these questionnaires. If I’ve seen it once, I’ve seen it 1000 times. Not exactly sure what the last sentence means, but it seemed appropriate and applicable.
- Best Practice: Truly, the best practice here is to operate your business in compliance with IC law so that when questionnaires are sent out and answered truthfully (as they must be), it becomes clear to the auditor that the contractor is in fact a bona fide independent contractor.
For more information on how to comply with independent contractor obligations, consult with an experienced independent contractor law attorney.
