The headlines associated with audits of independent contractor vs employee relationships have died down, but the revenue agencies are still aggressively pursuing these areas. It’s essential that you have clear documentation that each contractor relationship you’ve entered into meets the legal requirements so that you can present these in the event of an audit and that contracts protect you from a contractor who’s not doing what is necessary to maintain the classification.
As we’ve worked with clients facing an audit by Washington State Department of Labor and Industries or Employment Security, we gleaned a few tidbits of advice directly from the mouths of the auditors that will benefit you when entering into and managing contractor relationships:
1. Know the Rules. There are federal and state requirements for a company to qualify as a “contractor” for your business so that both you and your contractor know the legal requirements for your relationship. Washington State has set forth an “all or nothing” set of requirements that are pretty straightforward. The Federal categories are more nebulous and are applied based on the facts and circumstances of the situation.
2. Payment to Individuals. One of the first things auditors look for in an audit is payments made to individuals. Under the law, a contractor must operate a separate business with its own UBI number. It’s not an individual, it’s a sole proprietorship. Payments made to individuals raise a big red flag.
3. Contract. A contract between the contractor and your business is a best practice to document the terms of your relationship such as the services, payment, liability, and dispute resolution provisions — but it does not provide definitive evidence that the contractor is in fact a “contractor” under the law. The contractor must meet all the requirements in order to be classified as such.
4. Liability for Taxes and Penalties. If your business and another company have entered into an independent contractor relationship and that contractor is reclassified as an employee in an audit, you will be liable for the back taxes and penalties associated with that “employee”. The auditing department will invoice your company for the amounts due and you cannot have those obligations transferred to the contractor. However, a carefully structured written contract can require a contractor to reimburse you for those costs.
Remember the default is that the person working for you is an employee and you must demonstrate that they meet the requirements to be classified as a contractor. Having an understanding of the legal requirements and putting in place clear documentation will provide peace of mind and a straightforward process in the event of an audit.