Independent Contractors and Audit Risks

Hiring Independent Contractors

Independent contractors are great – you can ask Barbara Business Owner, Brandon Business Owner, or Holly Human Resources. They will all agree that there is a time and place when contractors are the ideal solution to a need in their business.

Independent Contractors can provide advanced skills and a flexible workforce to meet the competitive nature of today’s business landscape. They allow businesses to capture talent focused on key projects and variable length projects. Having freelancers allows the business to capitalize on specialty skills without the expense and hassle of hiring an employee.

Independent Contractor Definition

However, what many business owners don’t realize is that engaging contractors comes with an inherent set of risk factors that may lead to an audit. There are certain conditions that must be met when engaging contractors in order to engage a worker as an independent contractor.

If this set of criteria is not met, or is even uncertain, regulatory agencies may determine that the same worker should have been working as an employee instead of an independent contractor. This difference is what is called worker misclassification.

Worker Classification: Independent Contractor vs. Employee

Essentially, classification refers to if a worker is an independent contractor or an employee. This classification affects their pay, tax withholdings, benefits, and total compensation package.

Employees are also afforded and provided the rights and privileges under law or regulations that freelancers are not. The assumption is that independent contractors are working under the same conditions and opportunities as a business has working with its customers.

Most businesses aim to engage workers as independent contractors for legitimate reasons. However, there are predatory businesses out there that have attempted to cheat workers out of the benefits of being a W-2 employee for nefarious reasons. This has led legislatures and regulatory agencies to crack down on worker classification. The more ways around these rules, the more rules the government puts in place.

Independent Contractors and Audit Risks

While well intentioned, these rules can lead to businesses risking an audit when engaging contractors. Like all business risks, not all risks are equal. Some are low level risk engagements and others are high risk – depending on how they employ contractors in their business.

Many of today’s small and medium sized businesses would assume that audits all come down to if the contractors tax paperwork is in order. But this is an oversimplification of a more significant issue. The core question comes down to classification. Can that particular individual be engaged as a contractor, or should they have been compensated as an employee?

Audit risks can vary from the type of work that an independent contractor is completing, the amount of behavior and financial control the independent contractor has over delivering the services, and other such factors such as what type of training is required by the company that has hired them. These are just a few of the factors that are taken into account to determine the outcome of an audit.

To assist determining if your independent contractors are putting you at risk of an audit, we have created an Audit Risk Quiz. A few quick answers will determine your audit risk level.

Click here to take the Audit Risk Quiz now.

ClearPath is a leading Human Resources Outsourcing company focusing on assisting employers to leverage the independent contractor labor market. We’re committed to helping business owners stay compliant and minimize the risks associated with their contingent labor requirements.

No Legal Advice Intended. This article includes general information about legal issues and developments in the law. Such materials are for informational purposes only and may not reflect the most current legal developments. These informational materials are not intended, and must not be taken, as legal advice on any particular set of facts or circumstances. You need to contact a lawyer licensed in your jurisdiction for advice on specific legal issues.