Tag Archive for: Contractors

Red Flags and Risk Factors

Risk Factors and Red Flags: Why IRS might audit you!

An audit is, in itself, not a bad thing.  we have come to equate audit with accusation or wrongdoing but an IRS audit is simply a review of the records.  Int his spirit, there is no reason to fear IRS audit.

In reality, the IRS audit process is triggered by assumption of wrongdoing and, without excellent records or an adept tax attorney paired with a skilled CPA, individuals and business owners have plenty to fear from an IRS audit.

Why IRS starts an audit

Most often, audits are begun because of suspicious activity.  Sometimes, mistakes are honest ones and sometimes IRS audits and discovers mistakes that they themselves didn’t see on first look.

Here are some of the reasons IRS can trigger an audit:

1. Honest mistakes

You’ll be fined regardless of  your intent, so ensure a competent CPA prepares your taxes.

2. Under reporting income

Businesses file their 1099s religiously.  It is in a business’ best interest to report payments to contractors, they get a deduction for so doing.  Contractors occasionally “forget” to report 1099 wages.  IRS knows the money was paid and they can easily track that no taxes were paid on that money.  Want to trigger an audit? Try hiding 1099 wages.

3. 501c write offs

Usually (and IRS bases most of its red flags on a mean) lower middle and middle class people do not donate large parts of their income to charity.  You may tithe, you may be the exception.  But, IRS is nota. fan of exceptions and large charitable donations with small incomes will trigger a second look.

4. Extraordinary business expenses

There are industry standards for business deductions.  If you write of a large format printer and you are in PR or marketing, IRS will likely see that as a legitimate expense.  That vacation to Costa Rica?  Less likely. Be conservative in writing off personal expenses as business expenses.

6. The home office

If you run your business out the converted horse barn and employees come to work in that space, your office is likely legitimate. If you claim 1/5th of your rent because you work in the kitchen, you may find IRS has something to say about it. The home office expense gets scrutinized.  If you take it, be prepared to defend it.

 

If IRS Audits your business, your best choice is to call a qualified tax attorney.

Am I at Risk?

Those of us in the middle are at a lower risk than those in the upper tax brackets and those who report no income at all.  After all, how do you live?

Adjusted gross income % of total returns filed in 2016 % of these returns examined in 2017
No adjusted gross income 1.69 2.55
$1 to $24,999 36.47 0.71
$25,000 to $49,999 23.33 0.49
$50,000 to $74,999 13.26 0.48
$75,000 to $99,999 8.59 0.45
$100,000 to $199,999 12.19 0.47
$200,000 to $499,999 3.60 0.70
$500,000 to $999,999 0.58 1.56
$1,000,000 to $4,999,999 0.26 3.52
$5,000,000 to $9,999,999 0.02 7.95
$10,000,000 or more 0.01 14.52
All returns 100.0 0.62

*source http://nerdwallet.com

 

AB-5 can it stand?

As we look forward from April into the second quarter of 2020 the question on many business owner’s minds is: will the rules outlined in AB-5 stand in the face of coronavirus? At the start of 2020, business owners’ level of concern about California EDD’s newfound power to audit businesses was high.  EDD was empowered and emboldened to audit businesses whose workers were misclassified as 1099s instead of W-2’s in the wake of the “Gig Work Bill”.  Concerns around the new criteria for worker classification outlined in Assembly Bill 5 were common at the start of the year, and many business owners chose to reclassify large portions of their workforce as W-2 wage earners from their previous roles as 1099 independent contractors.

And then there was coronavirus.

With the social distancing, quarantine and shelter-in-place rules that have been put into place to try to #flattenthecurve of infections from the novel coronavirus, businesses have laid of large percentages of their workforce.  As of today, April 2nd, 2020 over 6.6 million workers have filed for unemployment, 87,900 of them in the state of California. When all of this is over and businesses reopen, can the California Employment Development Department really audit businesses using the strict independent contractor classification rules set forth in AB-5?

AB-5 can it stand?

The post-COVID-19 world of work will look different.

One thing is certain in this time of uncertainty, the world of work will be transformed by this “new normal” we are all experiencing.  While many workers are struggling to implement home-based work regimens, others are discovering the benefits of a flexible schedule and more family time. When business resumes, there is sure to be a shift in the expectation of many employers.  With that shift and the slow restart to the economy that will accompany the recovery post-coronavirus, many businesses will choose to hire part time contractors as opposed to diving into the commitment of a full-time W-2 employee. And while workers will have a different set of criteria they desire in order to go to work in an office again, business owners will also have choices.  business owners will have to choose wisely how to spend money as they try to restart what has come to a halt during the outbreak.

Even if they want to, many business owners will not be able to employ W-2 workers.

The US economic recovery may take years after this downturn and the massive unemployment caused by the COVID-19 crisis.  If an employer can start creeping back into some semblance of their previous business, would CA EDD really leap in and audit that business? The answer is yes.  If an employer categorizes their independent contractors incorrectly, CA EDD will audit and under AB-5 they have every right and a responsibility to do so.

What can a business owner do to allow for 1099 contractors?

The most important step a business owner can take is to examine the way their business is structured.  There are exemptions to AB-5 and service models are one of those exemptions.  If a business can be restructured to fall into one of the exempted categories, then that business could legitimately hire 1099 contractors.  However, it is important to note that EDD can investigate any business.  So, if you do restructure and choose to hire 1099 contractors, be sure they are legitimate businesses in their own right.  Verify 1099 contractors using tool like clear1099.com or call the team at Milikowsky Tax Law.  We can review your corporate structure and make recommendations based on your industry and goals for the next stage of your business.

We don’t know if AB-5 will hold in the face of Coronavirus.

It is impossible to know what the next few months will hold.  As business owners we have to do what is best for our businesses and our families.  That may be a restructure to allow more flexibility in hiring.  The pandemic will not last forever and, as business gets back to normal, the last thing anyone wants it to be targeted for an audit.  If you are concerned about EDD audits, please reach out to our office.  We are working from home too and happy to take your call. (858) 450-1040

COVID-19

Unemployment claims are in the millions as a result of the coronavirus epidemic and the ensuing quarantine and lockdown. Small businesses are being deeply impacted by the downturn and many are having to lay off over half their workforce. Since the start of the outbreak, 3.2M people have filed for unemployment in the U.S. and more than 1M people filed for unemployment in California.  As restaurants and other businesses reliant on in-person services, foot traffic and face to face interactions reduce their workforce by large numbers to try to stay afloat and ride out the COVID-19 crisis, many more workers will be forced to file for unemployment.  

COVID-19

Coronavirus global pandemic outbreak

Business owners who lay off portions of their workforce, both 1099 and W-2, due to the global slowdown from COVID-19 should communicate clearly with those people who are let go, informing them of their ability or lack of ability to file for unemployment.  To quickly review: a 1099 contractor can only file for unemployment if their independent business is folding, not if they lose contract work with one of their clients (you). A W-2 worker can file for unemployment benefits listing their most recent full time employer with no negative ramifications to the business entity listed on the unemployment documentation. 

As small to mid-sized businesses (under 500 employees) prepare for the many possible repercussions of the coronavirus outbreak they should be aware that one of the possible effects could be an uptick in EDD audit activity.  The California Employment Development Department audits businesses for many reasons. One of the surest ways to trigger an EDD audit, however, is to have a 1099 contractor incorrectly file for unemployment. If your company has released 1099 contractors due to the downturn from coronavirus and those 1099 contractors in turn file for unemployment listing your business as their most recent employer (whether through ignorance or malice), EDD is likely to audit your company. 

Communication and education are the best friends of business owners looking to protect themselves from unnecessary, time consuming and potentially damaging or even criminal investigations and audits by CA EDD. As a business owner you must: 

Inform workers who are let go of their status.  

Remind them that 1099 contractors cannot file for unemployment unless their own independent business has folded. 

Keep impeccable records. 

The following business records should be kept for each 1099 contractor you hire: EIN’s, evidence of a contract, copy of the contractor’s business card, the contractor’s website or evidence they are promoting their own business, business tax license, and Professional Licenses.

Do your research

The law changed at the start of 2020 and EDD is auditing businesses who hire a large number of 1099 contractors.  Know the new criteria and when in doubt, double check a 1099 contractor’s status using a tool like clear1099.com or other reliable reference. 

Above all if you are audited by CA EDD, reach out to a qualified ta attorney.  We can help mitigate the damage an EDD audit can cause.

handcuffs and mullet

IRS Criminal Investigations, How They Begin and Why

IRS Criminal investigations begin with a suspicion of fraud and violations of:

  • Internal Revenue Code
  • Bank Secrecy Act
  • Money laundering statutes

…Among others.

When IRS determines there is a case against a violator, they refer it to the Department of Justice.

Why IRS Special Agents target a business for investigation

  1. An IRS revenue agent, an auditor detects possible fraud.
  2. An IRS Revenue officer – a collections officer detects possible fraud.
  3. A member of the community reports possible fraud.
  4. Another agency, such as law enforcement or EDD or state tax board reports possible fraud.

What happens if an IRS Audit is begun?

  • The primary investigation starts  when the special agent’s front line supervisor looks at the initial findings and decides whether to continue the investigation.
  • Then a subject criminal investigation commences.
  • At this point, at least two Criminal Investigators at a management level have reviewed the ‘primary investigation’ material and determined there is sufficient evidence to initiate a subject criminal investigation*.

The Process of a Criminal Investigation

The special agent works closely with IRS Chief Counsel Criminal Tax Attorneys during the course of the criminal investigation.  AS in any criminal case the accused, or investigated, party has rights.  Among those rights are the right to counsel. IRS Special Investigators will gather information by any means necessary.

  • Interviews of third party witnesses
  • Surveillance
  • Search warrants
  • Subpoenaing bank records
  • Reviewing financial data.

A determination is made to go to trial or not

If the special agent determine that the evidence does not substantiate criminal activity, then the audit is discontinued.

If the special agent determines that the evidence does incriminate, then prosecution is recommended and a prosecution recommendation is sent to:

1.  The Department of Justice, Tax Division, (if it is a tax investigation) or
2.  The United States Attorney for all other investigations.

Prosecution by the Dept. of Justice

Once the case is turned over, the IRS special agent turns over all findings to the lawyers for the prosecution and is no longer involved in the case. The ultimate goal of an IRS Criminal Investigation prosecution recommendation is to obtain a conviction – either by a guilty verdict or plea. There are approximately 3,000 criminal prosecutions per year * as of 2017.

If IRS Criminal Investigators contact you, know your rights, contact a qualified Tax Attorney immediately and take the 5th amendment which is the right to remain silent.

*https://www.irs.gov/compliance/criminal-investigation/program-and-emphasis-areas-for-irs-criminal-investigation

Men on a construction site

In the face of a perceived increase in the number of independent contractors, the California Employment Development Department (EDD) has begun a campaign of stricter enforcement of employment tax laws. With EDD conducting more audits of California business’ employment records, business owners and their bookkeepers should be prepared for the possibility of an audit.

If EDD should initiate an audit of your company here are 7 steps you can take as you navigate the process.

Understand the Type of Audit

There are two types of EDD audits – verification and request. Verification audits are initiated randomly, not because of any perceived wrongdoing within your business. Request audits, however, are initiated because the EDD has reason to believe there may be inconsistencies in your records. Request audits should trigger a call to your CPA and Tax Attorney as they indicate that EDD has reason to believe you are violating the law.A request audit is more serious simply because the EDD is already suspicious, but both types of audits are conducted in the same way. 

Contractors or Employees?

Enlist Legal Aid

If you receive a notice of audit from EDD, reach out to a trusted legal representative, a tax attorney, immediately. Your business will receive a package with an audit notice, questionnaire and records request. Bring the package to your tax attorney and sign the EDD Power of Attorney form which allows EDD to communicate directly with your attorney to resolve the discrepancy.

Review Your Employment Contracts

The goal of EDD audits is to ensure that you are properly paying employment taxes and fairly compensating employees. One of the key concerns is whether or not workers are independent contractors, which should be clearly spelled out in your employment contracts. Take some time to review your employment contracts before the EDD does, to look for potential red flags and make updates where necessary. For instance, if you require someone to work a set schedule or attend a training, you probably cannot classify them as a contractor. If you are having trouble determining how to classify your workers, reach out to your tax attorney for expert advice. They will be able to help you define worker classification from a legal standpoint.

Gather Supporting Documentation

California has strict rules about who you can classify as an independent contractor. One way to make the case that a worker is a contractor rather than an employee is by proving they run their own legitimate business. Gather up as much documentation as you can in advance of an EDD audit, including: official invoices, company-stamped letterhead, business cards, or anything else from a contractor that verifies their independence.

File Your Taxes on Time

An easy way to avoid an unnecessary EDD audit is to file your quarterly taxes on time. While timely filing in no way exempts you from an EDD audit, it is good business practice and raises fewer red flags.Filing taxes, keeping clean and accurate orderly records and storing your documents in a n easy-to-access location is both good for business and can ease the process of an audit, merger, sale or other business needs. 

Update Your Employment Practices

Staying on top of employment laws and adjusting your record keeping, contracts and hiring practices is the best way to avoid an EDD audit. If your business is correctly classifying contractors and employees, an audit from EDD is a time consuming but not business threatening event.

Contact Milikowsky Tax Law for EDD Audit Support

Your focus is the running of your business. We are experts in tax law and can navigate the process of your EDD audit with you.The team at Milikowsky Tax Law is here to help you perfect your employment practices and navigate your next EDD audit. As former business owners ourselves, we understand the challenges small business owners face and we are committed to defending California business owners in tax law matters. When you have questions and concerns, we have answers. Contact our tax attorneys before, during, or after an audit to get trusted legal counsel.

A man using a laptop

The California Supreme Court recently heard a case that is changing the rules on the classification of Independent Contractors in the state of California.  Previously, there were 13 factors that EDD would look at in assessing whether a worker was a contractor or an employee.  In October of 2018 that changed when the Dynamex case was decided by the California Supreme Court.  The classification of contractors now rests on three factors and the default is now that workers are employees.

The three factors of the new laws that EDD will be using to classify workers are:

  • The worker is free from the control and direction of the hiring entity in connection with the performance of the work, both under the contract for the performance of the work and in fact.
  • The worker performs tasks that are outside of the usual course of the hiring entity’s business.
  • The worker is customarily engaged in an independently established trade, occupation or business of the same nature as the work performed for the hiring entity.

If you have concerns around your classifications or, if EDD has contacted you about an investigation, contact the team at Milikowsky Tax Law today.

 

The penalties for misclassifying workers can be steep and EDD can retroactively charge your company for payroll taxes dating back 3 years. Additionally, Worker’s compensation may not have been paid.  Be certain, be prepared and reach out to Milikowsky Tax Law today.

The information contained on our website and in blogs is provided for information purposes only and does not constitute legal advice.

Man on a phone

Businesses who are paid in cash have a responsibility to report payments over $10,000 to IRS using form 8300.  Form 8300 is similar in function to a 1099 in that services paid for from one business to another usually generate a 1099, submitted by the company who received the work and sent to the company who performed the work in question. In the case of form 8300 it is the responsibility of the payee to report the cash payment both to IRS and to the payor for his or her records.

Watch this video to learn more about who should file and what the penalties for failing to do so are.

 

The penalty for failing to file form 8300 is $100 per infraction.  For a single transaction that fine is $200, $100 for the failure to inform the payor that you filed form 8300 with IRS and $100 for failing to file the appropriate form with IRS. So, in case of large cash transactions, be sure to fill out the correct forms and report those cash payments to IRS. Avoid red flags that might trigger not only a penalty but possibly a deeper dive into your records and an audit by IRS.

 

The information contained on our website and in blogs is provided for information purposes only and does not constitute legal advice.

Man and woman looking at a laptop

Risks of Misclassifying Independent Contractors and Employees

Is the person you just hired a 1099 contractor or an employee? Making a false assumption could be costly. In California, there is a fine line separating these two categories of workers and significant penalties for misclassification. 

Here are some of the consequences you might have to face for mislabeling your contractors and employees, and tips on how to ensure that you classify workers correctly. 

Possible Consequences of Misclassification

Companies in California that mislabel their workers could face steep penalties from both state and federal agencies. Therefore, businesses of all sizes should take special care in ensuring they are in compliance with state employment laws and not taking risks. 

Here are just some of the consequences you may face for a violation:

  • Employers can face state-imposed fines of $5,000 to $15,000 for each known misclassification. The fines increase to anywhere from $10,000 to $25,000 if an employer displays a pattern of illegal behavior. 
  • Violators are required by California state law to post a notice about their infraction in a prominent location on the business website for one year. If a website doesn’t exist, the notice must then be posted at the physical place of business where the infraction occurred. 
  • IRS may require employers to pay both their share and the employee’s share of FICA tax, as well as the employee’s portion of FUTA and income taxes. 
  • Penalties may be assessed in the amount of 1.5% of the employee’s federal income tax liability, plus a 20% penalty against the amount of FICA tax that should have been withheld.
  • Companies caught misclassifying workers may have to pay an additional penalty equal to 10% of the unpaid unemployment and disability insurance that was supposed to be withheld. 
  • Companies can be charged with a misdemeanor that carries a $1,000 fine, a one-year jail sentence, or both. 
  • Companies may be required to pay the unpaid state income tax, unemployment insurance, and disability insurance that would have applied during the period of misclassification. 
  • Finally, the employee that was misclassified can also take legal action against the employer and seek up to three years of unpaid wages and penalties.

The exact amount a small business may pay in violations depends on the circumstances of the violation and the discretion of the enforcement agencies. However, in all cases, the financial and reputational damage is too great to ignore. If you have any questions regarding worker classification or you’re facing an EDD audit, contact Milikowsky Tax Law to schedule a consultation right away.

Properly Classifying Workers

The best thing you can do to remain in compliance is to never assume whether someone is a contractor or an employee. You should have a clearly outlined process to determine exactly how you classify workers. This may take time and consideration, but it’s absolutely worth it to avoid the aforementioned federal and state penalties. 

Here are a few tips:

  • Operate on a case-by-case basis. Don’t base your classifications solely on job title or past precedent. Evaluate the facts of each employment relationship individually before deciding whether someone is a contractor or employee. 
  • Apply “Right-to-Control.” The law determines whether or not someone is a contractor largely on the amount of control the employer has over them. The EDD evaluates three factors: behavioral, financial, and the nature of the working relationship. Using these criteria to make classifications ensures that new hires are compliant. 
  • Partner with Experts. Given the penalties for misclassification, small businesses can’t afford to make a classification mistake. Rather than trying to learn the intricacies of employment and tax law, most small businesses choose to work with outside experts who take a methodical and systematic approach to worker classification.

While the IRS does make distinctions between intentional and unintentional violations, there isn’t a clear precedent for what constitutes either — and hefty fines can be issued no matter what. The best-case scenario is one in which you onboard all new employees using the same process and correctly classify them as either contractors or employees, thereby avoiding violations altogether.

If you have questions on this matter, please reach out to Milikowsky Tax Law for guidance. Our team is well-versed in worker classification and can help you address your concerns or prepare for an upcoming EDD audit.

The information contained on our website and in blogs is provided for information purposes only and does not constitute legal advice

Two people looking at a graph

California EDD: 1099 Contractors vs Employees How to tell the difference

The primary goal of the California Employment Development Department is to investigate companies whose employees are potentially mis-classified as contractors when they should be classified as employees.

When determining whether your workers should be classified as employees or 1099 contractors take the example of the pLumbing Company who hires additional plumbers to handle an excess of work at a given time.  Those workers do exactly what your employees do and therefore would be classified by EDD as employees.

There are new tests to help employers determine whether your workers should be contractors or W-2 wage earners.

Here are those 13 factors that EDD uses to determine whether your workers are contractors or employees. The criteria are grey and if you find you have inadvertently run afoul of CA EDD, reach out to a tax attorney immediately to help you resolve these cases of mis-classified contractors and employees.

Questions 1 – 3: “Yes” indicates the worker is an employee.
1. Do you instruct or supervise the person while he or she is working?
            When a worker is required to follow company procedure manuals and/or is given specific instructions on how to perform the work, the worker is normally an employee.
2. Can the worker quit or be discharged (fired) at any time?
            Independent contractors are engaged to do specific jobs and cannot be fired before the job is complete unless they violate the terms of the contract.
3. Is the work being performed part of your regular business?
            Do you use the worker in everyday operations or from time to time for specific tasks? Could you use another worker for the next instance of that task?
Questions 4 – 6: “No” indicates that the worker is an employee.
4. Does the worker have a separately established business?
            Does the worker perform similar jobs for other clients, advertise for his/ her own business in publications, hand out business cards?
5. Is the worker free to make business decisions which affect his or her ability to profit from the work?
            Independent contractors are in control of their own acquisition of equipment  and facilities.
6. Does the individual have a substantial investment in their job which would subject him or her to a financial risk of loss?
            Independent contractors furnish the tools, equipment, and supplies needed to perform the work.
Questions 7 – 13: ”Yes” indicates the worker MAY be an employee.
7. Do you have employees who do the same type of work?
            Is the work being done to handle an extra workload or replace an employee who is on vacation, a worker is hired to fill in on a temporary basis.
8. Do you furnish the tools, equipment, or supplies used to perform the work?
            Independent contractors furnish the tools, equipment, and supplies needed to perform the work.
9. Is the work considered unskilled or semi-skilled labor?
            Workers who are unskilled or semi-skilled are the type of workers the law is meant to protect and are generally employees.
10. Do you provide training for the worker?
            Independent contractors usually do not need training.
11. Is the worker paid a fixed salary, an hourly wage, or based on a piece rate basis?
            Independent contractors agree to do a job and bill for the service performed.
12. Did the worker previously perform the same or similar services for you as an employee?
            Once an employee, always an employee.
13. Does the worker believe that he or she is an employee?
            Intent is a factor to consider when making an employment or independent contractor determination.
Business owners should be aware of the common mistakes when hiring and working with 1099 independent contractors

Business owners hire independent contractors to help with specialized or contracted work. But, as a business owner, if you find yourself engaging in what may be considered an ‘employer-employee relationship’ with your independent contractor hires, you may be contacted by the Employment Development Department (EDD) and/or the Internal Revenue Service (IRS) for a potential misclassification audit.

Misclassification is one of the reasons EDD may conduct an audit of your business. These audits might result in:

  • Penalties
  • Fees
  • Back taxes owed
  • Potential criminal liability.

How Do You Know if You Should Hire Someone as a W-2 Worker or a 1099 Independent Contractor?

Choosing to hire a worker as either a W-2 worker or a 1099 independent contractor requires knowing the criteria for classification and how the worker’s services dovetail with your current company offerings. When you consider the correct worker classification, consider who holds the right of control. The right of control looks at these three criteria to aid in determining classification:

 

  • Behavioral Control: Are you in charge of the manner in which workers perform their duties?
  • Financial Control: Do you pay regular wages and have the ability to fire the employee?
  • Relationship to business: Is the employee an essential part of helping your business run?

 

A W-2 worker is someone hired for a specific job, is given set work hours, receives benefits, works for one specific employer, and has taxes deducted from payroll.

1099 independent contractors, on the other hand, are hired on a contractual basis for a specific task, are paid a set fee, do not receive benefits, do not have taxes deducted from payroll, and have more work flexibility overall. 1099 independent contractors can work for multiple employers simultaneously.

For example, an administrative assistant hired as a W-2 would show up during regular set work hours and complete set tasks for the job in their scope of work. They receive benefits, are taxed on payroll, and report to a higher authority.

An administrative assistant hired as a 1099 would have his or her own business entity, set their own scope of work, invoice the company for work performed, and would work for other employers simultaneously. Once the scope of work is completed, they no longer work for the company.

Before hiring someone as a W-2 or a 1099, make sure they fit the new strict Assembly Bill 5 (AB-5) classification requirements to avoid triggering a government audit of your business.

What is AB-5?

AB-5 is a California law put into effect January 1, 2020 that changed previous worker classifications. Before AB-5, EDD classified employees through the Borello test. This test had looser, less clear requirements for classification. Now, the agency set forth clearer rules and regulations, called the ABC test, regarding classification between W-2s and 1099s.

What Are the ABCs of Contractor Classification?

The ABC test under California’s AB-5 regulation explains that all workers are considered W-2 employees who receive benefits and payroll taxes unless all three of the following criteria are met:

  • “The worker is free from the control and direction of the hiring entity in connection with the performance of the work, both under the contract for the performance of the work and in fact;
  • The worker performs work that is outside the usual course of the hiring entity’s business; and
  • The worker is customarily engaged in an independently established trade, occupation, or business of the same nature as that involved in the work performed.”

 

Why Does the Government Care about Correct Worker Classification?

When workers are misclassified, the government does not receive the correct payroll taxes. Incorrectly classifying W-2 employees as 1099 independent contractors also strips the worker of benefits they would receive as W-2 employees.

Companies who incorrectly classify employees as contractors save money in workers’ compensation, payroll taxes, paid time off, benefits, and retirement accounts.  Because of these savings, they may be able to undercut the competition at the sacrifice of their workers.

Businesses who adhere to the W-2 classification criteria might report other companies for this kind of misclassification because it creates an unfair playing field for businesses who adhere to regulations.

Not every business that uses 1099 contractors is predatory or wrong in their classification. Many businesses use 1099 contractors correctly. When working with independent contractors, there are a few pitfalls to be aware of so you don’t accidentally treat your independent contractors like your employees.

 

Common Mistakes When Working with Independent Contractors 

Here are a few behavior scenarios that could lead to potential issues when working with independent contractors:

1. Not Renewing Scope of Work

Contractors are normally hired to work on a per-job or project basis. They submit a Scope of Work with clear Key Performance Indicators (KPIs) and report on the hiring entity’s Return on Investment (ROI).

Even if the relationship lasts years, the 1099 worker or outsourced company will invoice the business using their services and maintain a contract and billing records. 1099s also have tax records to show that they pay their own income taxes on the money paid to them by the hiring entity.

 

2. Dictating the Use of Equipment or Software

Contractors determine the tools and equipment to use for their job. A contractor who provides a service that requires the use of your internal software is not automatically a W-2. It is important to be clear in the proposal that they will provide their own schedule, deliverables and likely will use other software to service other clients.

 

3. Setting a Schedule for Contractors

While contractors can be required to be on calls at set times, you cannot suggest or direct when a contractor takes breaks or even what time of day they need to start work.

By establishing a schedule for your contractor outside of assignment deadlines and scheduled agreed-upon calls, you could be seen as engaging in an employer-employee relationship.

 

4. Making Contractors Work in the Office

If contractors are working in your offices or place of business, this may cause some labeling issues when determining if they are a contractor or an employee. If a contractor is working out of an office alongside full-time or part-time employees, they might be confused or misclassified as an employee, especially if they are working similar hours and performing similar tasks.

 

5. Paying Wages and Expenses Incorrectly

Salary or hourly wages are reflective of employee behavior. To avoid any confusion, it’s best practice to pay contractors by project or retainer. Contractors pay for their own resources and supplies. While they may work in your CRM (in the case of an outsourced marketing agency), they will have their own project management software to manage their internal workflows.)

 

6. Requiring the Contractor to Only Work with Your Business

Unlike W-2 employees, independent contractors have the flexibility to work with multiple employers at once. At any given time, they may choose to only take on your business alone, but this is at their discretion. If they choose to work with seven different businesses at once, they have the right to do so.

By asking them to sign a non-compete agreement, you treat them as an employee rather than a contractor. This means they must receive the benefits that employees receive. Instead, your business can communicate with the independent contractor about a confidentiality agreement to keep your business’s information secure. 

 

7. Not Verifying Contractor Status

In order for an independent contractor to be properly licensed and classified, they should have the following criteria: 

  • Verified website or social media accounts 
  • Client base 
  • EIN number 
  • Business license

If they are missing any criteria, the best practice is to communicate with the contractor so they can provide any missing information. 

 

What Triggers EDD Audits?

Although the government agency performs random misclassification audits of businesses, they do audit businesses when they are flagged. Triggering an EDD audit can come in many forms, but they all have the same outcome – an audit of your business.

Be aware of the top four EDD audit triggers to help your business steer clear of an audit. Remember there isn’t a foolproof plan to avoid an audit, but staying away from the common triggers can help set your business up for success. 

  1. Having an independent contractor who files for unemployment
  2. Employee complaints
  3. Filing your business taxes late
  4. Randomized verification audits

Read on for more about why each instance triggers an audit and how you can prepare.

The Employment Development Department is meticulous with the audit process and takes misclassifications seriously. Misclassifying even one worker can trigger an EDD audit of your business. These audits are serious and can result in fines and penalties of thousands, if not hundreds of thousands of dollars.

If your business is undergoing an EDD audit, learn more about what to expect in an EDD audit here.

 

 

business owners should avoid key mistakes when hiring and working with independent contractors