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The Proper Use of Independent Contractors

By

Nancy E. Joerg, Esq.

Senior Attorney and Shareholder

April 2009

Look before you leap! In this poor economy, there are a lot of reductions in force. Companies may find they need people with certain skills, but they are understandably afraid of expanding their workforce with regular employees. A smart solution is to supplement the workforce with independent contractors, but companies are reluctant to use independent contractors because they feel it may be high-risk.

Now that President Obama is in office, we can expect to see some additional legal enforcement action regarding the use of independent contractors. The Independent Contractor Proper Classification Act was proposed in 2007 but not yet passed. It was supported by Obama in 2007 when he was a Senator. During his presidential campaign, Obama said he favored this legislation which indirectly limits and discourages the use of independent contractors. The Bill has not been resubmitted to Congress for consideration in 2009, although it may very well be introduced later in the year.

The good news is that you can dramatically limit your risk in using independent contractors if you have documentation to prove the workers are really independent contractors in the event of a legal challenge.

The underlying truth of independent contractor status is that all independent contractors must be, by definition, self-employed. The world of independent contractor status is "black-and-white." If an individual is self-employed, he/she is an independent contractor. If an individual is not self-employed, then that individual is an employee of someone else. This simple principle helps clients to understand the (sometimes intimidating) world of independent contractor status.

What are some indications that an individual is self-employed? Self-employment is often shown by the individual having a business name, business reputation, advertising, his/her own place of business, his/her own client base, paying his/her own expenses, filing taxes under his/her own business name, etc.

Below are ideas on how to have a generally strong independent contractor:

1. INCORPORATION: If the independent contractor is incorporated, this is a terrific fact for independent contractor status. If you are fortunate enough to have an incorporated independent contractor, then, of course, you should be issuing all checks to the corporate name. Try to only use independent contractors who are incorporated in good standing. Incorporation will not make your company bulletproof, but it is certainly a very strong fact for independent contractor status.

Check the Secretary of State's website on a yearly basis to verify that each corporation is in "good standing." In Illinois, for example, the website is www.cyberdriveillinois.com. In Minnesota, the website is www.sos.state.mn.us. Print out the proof of good standing and put it in the independent contractor's file.

2. BUSINESS NAME: If the independent contractor is not incorporated, and not willing to become incorporated, then you want to make sure that the independent contractor has a business name as a sole proprietor - and uses that business name as well. You should be making out checks to their business name and having them endorse those checks with their business name.

3. BUSINESS CARDS: The independent contractor should have a business card in his/her own business name showing that they are independent and holding themselves out to the public. The independent contractor should, of course, pay for the business cards.

4. INVOICES: The independent contractor should invoice you project by project on an invoice form that the independent contractor designed, obtained, and paid for themselves with the independent contractor's business name at the top of their invoice. Auditors are very impressed when independent contractors invoice companies (this is something that employees never do - so invoices are a nice way to highlight that this is not an employment relationship and not intended to be an employment relationship).

5. ADVERTISEMENTS: Have the independent contractor place an ad in a newspaper under the independent contractor's business name, advertising the services that he/she does. Don't place the ad for the independent contractor; the independent contractor should place his/her own ad. Be sure that you get a copy of the ad and put it into a file for the independent contractor. The ad can be in a small-town newspaper; it doesn't need to be an expensive ad. (When you clip out the ad, also clip out the date and name of the publication.)

6. BUSINESS EXPENSES: The independent contractor should ideally pay for every aspect of his/her business overhead. You should not be paying for any of the independent contractor's transportation costs, equipment, pagers, beepers, telephone bills, business cards, letterhead, etc.

7. INDEPENDENT CONTRACTOR FILES: Set up independent contractor files for each and every independent contractor. In those files, have such things as business cards, ads, invoices, etc. You must have well-documented independent contractor files which will help to show an auditor that the independent contractors are set up as independent businesses, separate and apart from your company. These files should prove that the independent contractors have their own business reputation, and, if you would close your doors tomorrow, the independent contractors could continue to function as self-employed entities.

8. WELL-DRAFTED INDEPENDENT CONTRACTOR AGREE­MENT: The independent contractor agreement should be tailored and unique to the specific relationship it depicts. Be sure that the independent contractor signs the independent contractor agreement with his/her business name and business title (such as Owner or President).

9. USE INDEPENDENT CONTRACTOR TERMINOLOGY: If you have anyone who works directly with the independent contractors, don't call that individual a "Manager" or a "Director" as those are words of supervision which indicate control and direction. You should instead use a word like "Coordinator." Check your website, applications, and all printed material to make sure you are not inadvertently referring to your independent contractors as employees in any way!

As companies increase their use of independent contractors, they need to have well thought out procedures in place to limit their liability in the use of independent contractors. Companies have tight controls in place that regulate the hiring of employees. However, companies often have no corresponding tight controls for contracting with independent contractors. This can lead to disaster when the auditor comes knocking on the door.

CONACT NANCY JOERG FOR A SELF AUDIT OF YOUR INDEPENDENT CONTRACTOR RELATIONSHIPS: I have been working with many companies to write and evaluate their independent contractor agreements, independent contractor files, websites, manuals, etc. Consultation on the proper legal use of independent contractors is essential. A yearly review of all independent contractor documents and operations is a prudent practice.

For example, certain industries have exemptions and if the company does follow the law with regard to the exemption, the worker will be reclassified to employee status (when the worker could have been an independent contractor if the requirements of the exemption had been followed). Certain categories of independent contractors require, by law, certain information in the independent contractor agreement (direct sellers, truck drivers, etc.) in order to comply with the exemption.

Companies using misclassified workers may be hit with hefty tax assessments, penalties and fines. Therefore, companies must become very knowledgeable about the proper use of independent contractors.

Companies often mistakenly think that if the worker signs an independent contractor agreement then the worker is an independent contractor. This is entirely false. The worker must satisfy the legal criteria for independent contractor status. If the legal criteria is not met, then a government agency (the IRS, state department of unemployment insurance, etc.), or even the worker, may seek to impose legal liability on the company (despite the written agreement stating that the worker is an independent contractor).

Another issue to consider in an evaluation of independent contractor status is IRS Safe Haven protection. Congress passed Section 530 of the Internal Revenue Act of 1978 in order to give relief to those businesses that, in good faith, used independent contractors (because of a reasonable basis). This law is liberally construed in favor of the taxpayer, so it pays to be both aggressive and creative under this law.

It has been my experience over the years that when a company has even a small amount of experienced consultation on the independent contractor issue, they are able to dramatically reduce their liability in their use of independent contractors. There are many "practical steps" that a company can take to lower its risk in using independent contractors.

If readers would like assistance with evaluating and strengthening a potential independent contractor relationship, please contact Senior Attorney and Shareholder Nancy E. Joerg at 630-377-1554 or via email at najoerg@wesselssherman.com.