Managing the independent contractor crackdown

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Should I be worried about the IRS’s new crackdown on independent contractors? What do I need to do to make sure my subs aren’t going to be a problem for my business?

—Full-service remodeler, Indiana

Absolutely you should be on alert that stepped-up enforcement of fines and charges for misclassification of employees as independent contractors is looming. However, you should have some peace of mind if you carefully follow the rules regarding independent contractor status and keep good records to show that you do so.

Employment attorney Scott Lenhart, of Lenhart Law, Atlanta, expects independent contractor misclassification to be one of the biggest issues for employers this year and next. “What I believe to be driving this new focus,” says Lenhart, “is the fact that governments see this as a means to collect money.” In addition to the IRS, Lenhart says numerous states have stringent laws on the books regarding independent contractor status, including Illinois, Indiana, New Hampshire, New Jersey, Minnesota, Rhode Island, Washington and—the strictest—Massachusetts. Delaware, Maryland and Colorado have new laws on contractor status, and Delaware’s applies specifically to construction workers. Lenhart says Pennsylvania, New York and Wisconsin are on the path toward adding their own independent contractor laws.

Sadly, many remodelers may misclassify workers by mistake, especially these days when they use workers on a project basis because business is down. But governments want to reel in revenue from all misclassification cases, inadvertent or not. “It’s a perfect storm,” says Lenhart.

The storm can cause a lot of damage. If you have misclassified a worker and are caught, expect to pay back taxes, interest and penalties, FICA, FUTA, Medicare, and so on. Expect to pay applicable state as well as federal penalties. Expect to pay workers’ compensation, liability and health insurance for the misclassified worker. Expect to suffer a sizable hit in administrative time and expenses, plus perhaps legal fees.

It can get worse. Horror stories abound. David Roberts, of Roberts Constructs Group, Evanston, Ill., says, “I was sued about 18 years ago by an ‘independent contractor’ employee carpenter that was injured on a project where I was the architect only. The situation was messy and everybody got sued. Our insurance carrier made a settlement and then promptly dropped us. We were on the outside looking in but we still got hurt. The contractor and client really took a beating and it soured a good relationship. Lesson learned.” Curb Appeal Renovations, a design/build remodeler in Keller, Texas, ran into trouble nine years ago when a mistakenly misclassified employee filed for unemployment compensation and filed a workers’ compensation suit. The experience was bad. But afterward, instead of employing all crews, Curb Appeal went the other direction.

“We’ve gone to 100 percent subcontractors,” says Robin Burrill, who owns the company with husband Rob Mathews. “This way we know upfront what our costs are going to be—no questions.” What’s different now, says Burrill, is that “I believe we’re doing all the right things” to avoid misclassification.

Three factors—behavioral control, financial control and working relationship—determine whether the IRS considers a worker to be an independent contractor. Here’s how the IRS puts it at www.irs.gov [1]: “If you have the right to control or direct not only what is to be done, but also how it is to be done, then your workers are most likely employees. If you can direct or control only the result of the work done – and not the means and methods of accomplishing the result—then your workers are probably independent contractors.” (For more detailed information, go to the IRS Website. Lenhart also recommends this from Illinois State University: )

To ensure that its independent contractors meet the IRS definition, Curb Appeal always follows the following steps:

• Lets the subs contract with other companies
• Sets job specifications, but doesn’t tell contractors how to do their job
• States what day the workers are needed, but doesn’t specify their work hours
• Requires contractors to submit a written bid for each project, and an end-of-job invoice based on that bid
• Requires them to provide all their own tools
• Requires them to carry their own insurance
• Requires them to sign a lien waiver every time they pick up a check
• Requires them to sign a W-9 each year
• Requires them to sign a subcontractor agreement each year, which refers to compensation as draw payments
• Requires them to sign a state-provided subcontractor document waiving workers' compensation
• Provides a 1099 for them at the end of the year

Paul Zuch has used subcontractors exclusively since launching Capital Improvements in Dallas more than 10 years ago. He follows the rules assiduously and has the records to prove it. Zuch is a strong believer in the independent contractor approach. As he says, remodelers with employees feel pressured to keep them busy, even when times are lean. Besides, employees “can drag things out, especially if jobs are few and far between.” By contrast, independent contractors are brought in only when needed. They are “highly motivated to get the job done quickly”—and get it done right the first time—“to hold to their bids,” says Zuch.

Remodelers with in-house crews argue that “they can control their guys better,” says Zuch. “That’s a farce. We can hold our trade contractors as accountable or more.”