Mark Pestronk
Mark Pestronk

Q:Last week's column covered the U.S. Department of Labor's new policy for differentiating independent contractors from employees. You noted that the test is "whether the worker is economically dependent on the employer (and thus its employee) or is really in business for himself or herself (and thus its independent contractor)." I seriously doubt whether my agency's IC relationships would pass this "really in business for himself or herself" test. What can I do to help avoid a labor audit and big bill for back pay, taxes and penalties?

A: The first step to consider is converting your ICs to employees for all tax and labor law purposes. This conversion is legal and will go a long way toward preventing an audit, even for the time period before the conversion.

I realize that unlike many industries ICs in the agency business generally do not want to be classified as employees, as they value their independence, even if it's only theoretical. Big resistance will probably come from ICs who used to own their own agencies. They may not have been employees in decades and don't want to start again now.

However, you can reclassify ICs without affecting their independence. They can still handle their own clientele as they wish (within limits) and your agreement with them can still provide that the clients are theirs.

The bigger adjustment is on your end: You need to start withholding taxes, follow the federal and state labor laws (including minimum wages) and provide W-2s instead of 1099s. Contrary to the belief of many agency owners, a person who is compensated entirely on commission can be an employee for all tax and labor law purposes.

With employees, the employer needs to kick in half of the Social Security and Medicare taxes that an IC would otherwise pay, so the transition actually saves the former IC some taxes. To compensate yourself for this hit, you would need to deduct 7.65% of the employee's gross income each pay period.

Next, assuming that you do not want to convert your ICs to employees, the two biggest steps that you can take to ward off involuntary reclassification are to require each IC to set up his or her own corporation or limited liability company and to require each such entity to obtain a business license and, where applicable, Seller of Travel registration.

If you encounter resistance from your ICs, even after explaining the reasons for these steps, you can help lessen it by providing forms and instructions and even paying the filing fees, which can be as much as $300, depending on the state where the independent contractor lives.

At this point, sharp readers will be wondering how these formalities make a worker "really in business for himself or herself." The answer is that they help make it appear that the IC is truly independent, and appearance counts.

In my experience, once an auditing government agency finds out that an ostensible IC has his or her own company and requisite licenses, the auditor desists, and the case is usually closed. I can't guarantee that these steps will ward off every audit, but I can guarantee that they will help.

There are other useful steps that you can take, and I will cover them in a future column.

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