Mark Pestronk
Mark Pestronk

Q: I am an independent contractor, and I am considering moving to a new host agency. The host has sent me its standard independent contractor (IC) contract, and I see that I must operate as either a corporation or a limited liability company (LLC) and not as a sole proprietor, which is how I have always operated. I also see that when I sign the contract in the name of my corporation or LLC, I must also sign a personal guaranty. This seems circular: If they want me to be personally liable, why require the corporation or LLC? If they want me to operate as a corporation or LLC, why require personal liability in the form of a guaranty?

A: The requirements that you describe are those that I recommend to my host agency clients. Let me explain why a host would want you to operate as a corporation or LLC and why the host would require a personal guaranty.

The two biggest problems that hosts face are: 1) the possibility of reclassification of ICs as employees by taxing authorities, thus making the host liable for withholding taxes, unemployment taxes and workers' compensation charges; and 2) fraud and embezzlement by rogue ICs, for which suppliers and clients hold hosts liable.

While there are many steps that hosts can take to avoid reclassification, and while the magnitude of this problem varies from state to state, the most powerful step is to require ICs to operate as corporations or LLCs. Under that arrangement, the IC contract is between two companies, and the host issues a 1099 form to the corporation or LLC.

In my experience, when a government auditor finds a business-to-business relationship like this, the auditor declines to examine the relationship any further and does not reclassify it as one of employer-employee. So a contract in the corporation's or LLC's name is a silver cross that frightens away the vampire tax collector.

The trouble with this arrangement is that most IC corporations or LLCs have few or no assets. If the IC commits fraud or embezzlement, the host has little or no recourse against the corporation or LLC.

Unfortunately, in my experience, IC fraud and embezzlement are all too common, and hosts are too often the victims. Every IC who can issue tickets (or who can just order tickets) has the power to run up hundreds of thousands of dollars in fraudulent credit card charges, for which the suppliers will hold the host (not the IC) solely responsible.

Even ICs who are established companies have defrauded their hosts after years of honest work in order to raise cash in a crunch. In many cases, the IC's corporation or LLC turns out to be just a shell with few or no assets.

The solution is the personal guaranty, which serves two purposes: First, it probably deters potential fraud and embezzlement; and second, it provides a more likely source of assets if the host needs to sue for a debt owed by the IC.

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