1099 Independent Contractor Classification Practices

Secure Talent Helps Your Business Prepare for an IRS Audit

Federal and state 1099 audits are a very real phenomenon. Any business can be a target for an audit by the Internal Revenue Service (IRS) or other federal or state governmental body and as a result, be exposed for worker misclassification. And because certain economic times always increase the use of independent contractors, and due to extreme tax liability, ensuring your company has a 1099 classification system that complies with IRS guidelines is essential.

The heightened level of information that exists surrounding employee misclassification should ensure that human resources departments, corporate legal counsel, CEOs and others are making proper classification a No. 1 priority – but many still feel a 1099 audit can’t happen to them.

It’s estimated the IRS is owed billions of dollars due to improper 1099 classification. And the agency is ramping up its efforts to collect that money. It was announced that the IRS will add 6,000 additional audits to its agenda in 2010. In addition, some legislation has stiffened the rules for 1099 classification, increasing penalties and fines for employee misclassification, including felony charges in some cases.

Economic Downturns: Manage Increased Risk for 1099 Audits

There are several reasons an employer is more exposed in an economic downturn. If independent contractors finish a project with a company and then file for unemployment, the state unemployment agency can investigate the 1099 relationship. Or, if consultants cannot afford health insurance, they could file for workers’ compensation benefits and that could spark an audit.

Employees laid off and reclassified as independent contractors performing the same or very similar duties may be working under improper classification and could spark an audit. Moreover, the IRS is offering incentives to those who participate in what is essentially 1099 classification “whistle-blowing.” If enough distraught or dissatisfied ICs at any one company exist, a class action lawsuit could ensue as well.

Other reasons a business may be targeted for a 1099 audit include:

• A business is chosen for a general tax investigation by an agency computer.
• A business is in an industry that’s known for increased independent consultant use.
• A federal agency such as the IRS audits an IC and then audits the business the 1099 professional performed services for.
• A business has a higher-than-average filing rate of 1099 forms.
• A business is chosen for a random classification check for the purposes of general enforcement.

Reduce the Risk of an IRS Audit Through Proper 1099 Classification

Secure Talent understands that audits know no boundaries. Your company is still at risk if you engage 1099 workers, regardless of size, geographic location or industry. Unfortunately, audit risk assessment is extremely difficult for most businesses to do, mainly because the regulations are ever changing and complex. Furthermore, 1099 classification is not a core competency of most businesses.

The best thing to do to prepare for a 1099 audit is to put a solid process in place that clearly defines the difference between an independent contractor versus employee. This process needs to stand up to IRS or other federal and state agency criteria. Assess your day-to-day actions with your 1099 workers and compare them to classification guidelines. These rules include the IRS 3 Factors/20 Questions test and a handful of other federal and state agency standards.

Review your existing corporate compliance plan with your ICs as well. Examine your records to determine what types of employment agreements you use with 1099s. Many businesses (unknowingly) aren’t thorough enough with the legal agreements put in place with independent contractors.

While it’s best to work with an expert to create a sound 1099 classification procedure, some documentation your company should have in preparation for an audit with the IRS or other agency include:

• Accounts payable, income and payroll documentation.
• Agreements in place between your company and those under independent contractor classification.
• Copies of all IRS 1099 forms issued.
• Documentation your ICs are in business for themselves.
• Invoices from your independent contractors, documentation of other companies they work for and information on current employees (if any).
• Names and addresses of all consultants working for your company.
• What services are performed by your 1099 workers.

And more ...

Disclaimer: The content in this Web site is designed to provide educational information and should not be considered legal advice.

Protect your 1099 workforce. Let Secure Talent mitigate your company’s risk so you’re prepared for an IRS audit by contacting us today online or calling 800.778.0197.