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The classification of an independent contractor has long been a battle between the employer and state agencies.   The misclassification of the independent contractor can create penalties and interest in unemployment as well as other employer and corporate taxes.    Most misclassifications are discovered by the unemployment agencies when the independent contractor files for unemployment benefits.

The definition of an independent contractor is a self-employed individual who supplies a set of services to a second or third party on behalf of a client.   A contract between a client and an individual does not prove the individual qualifies as an independent contractor.   The DOL, IRS, and unemployment agencies all have separate ways of determining if the individual is an independent contractor.

The DOL provides the ABC Test, which states the individual is free from direction and control, and the services performed are not typically performed by the client, and the individual must be customarily engaged in providing independent contract work to several employers.   The IRS has established a twenty-point list for employers to use for the evaluation.  From an unemployment perspective, the following are the basic requirements for this classification: they pay their taxes to all jurisdictions, Insurance or other benefits are not supplied by the client, they use their equipment, and the client has no direction or control over the individual.  The rules for all fifty-three jurisdictions will vary.

So, how can an employer be sure the individual meets the specifications of an independent contractor?   For each independent contract that is established, the employer could apply the ABC Test, the 20 Point test and read the unemployment legislation of the applicable state.    This should reduce the exposure of the employer.   Taking this a step further, an employer could ask for approval from the IRS and the unemployment agency involved as the contracts are secured.   The later process is slow moving but reduces the exposure to misclassification even more.   The method most often used by employers is to wait until the state discovers the misclassifications.  The employer is then required to file amended quarterly contributions returns along with submitting interest and penalty on the contributions owed.

To increase integrity of the unemployment systems and improve the trust fund balances, states have become aggressive if they suspect there is misclassification of an independent contractor.  On almost all state registrations, a question is asked – “Do you have individuals who perform work that you do not consider an employee?”   As we stated earlier, independent contractors become unemployed and try to collect benefits as a claimant.  The result is an investigation to determine if the client is defined as an employer of this individual.   This can trigger a company-wide audit to determine if other individuals are misclassified.

If you should need assistance or have questions regarding this matter, please contact your CCC Tax Analyst.

 

 


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