I have been called to assist in many Department of Labor issues which tie in closely with Worker's Compensation Insurance and Disability Insurance. It's imperative that small business owners know and understand how this all works together, and get the appropriate counsel from their accountants, lawyers, and insurance brokers regarding proper insurance coverage and necessary paperwork.
Firstly, there should be a standard system in place when working with a new vendor. A vendor packet consisting of documents required by tax law, insurance certificates, and contracts should be collected before working with, and most importantly, paying any vendor. We will outline what particulars should be requested from each vendor - whether a corporation or a sole proprietor.
- The vendor should sign a written agreement attesting to the fact their company or he/she is an independent contractor. This is usually referred to as a freelancer agreement or independent contractor agreement, or simply a contract. The document should clearly indicate compensation amount and frequencey [hourly, weekly, project based, etc]. It is different from a confidentiality agreement which only guarantees confidentiality and does not determine vendor status. Confidentiality agreements can be signed by employees and independent contractors alike.
- A W-9 should be completed and signed. [Employees complete W-4 and I-9]. It should be clear to your accounts payable department what name checks should be issued in, and what the vendors company status us [incorporated, partnership, sole proprietor, etc]. Best to keep the original in a binder where all W9 are kept, and a copy should be kept in the vendor's file. IMPORTANT if a vendor does not complete a W-9 you are required by law to withhold 28% of whatever you pay them, for federal tax purposes. You should get a W-9 form from every vendor, regardless of status as sole proprietor or corporation.
- A business card should be obtained and kept on file. Preferably several of them, one to keep in your card file, one to staple to a copy of the completed W9, and one to include in a folder with other vendor setup documents.
- Postcards, brochures, flyers, or display ads showing the vendor markets themselves should be kept on file. Most people know how to use desktop publishing software, so it should not be difficult to obtain professional looking marketing materials from your vendors. If they don't have such materials, chances are they are NOT marketing themselves, and should be avoided.
- Printouts of the vendor's professional website or profile, and a client list, should be kept on file. Anything that can show a marketing or networking effort by your vendor. Some auditors have accepted social website profiles as proof an individual is seeking out work, but a professional website is always preferred. You should try to use vendors who obviously advertise.
- The vendor should actually bill the business for the services rendered via professional invoices the vendor creates. Emailed notes about hours or days worked, or handwritten invoices are unacceptable.
- The person should be required to have their own worker's compensation insurance and disability coverage. New York State laws are ambiguous about insurance. Currently individuals [sole proprietors] and officers of corporations that have two or less shareholders are not legally required to obtain insurance. However, the NY State Worker's Compensation Board determined that if you enlist the services of such vendors, you are liable for their coverage, and if audited, are responsible for paying premiums if it is determined that the vendor should have been considered an employee. All the more reason why every effort should be made to clearly establish the vendor as an independent contractor. Furthermore, worker's comp claims can be brought against you by the vendor AND by the vendor's subcontractors [frightening]. It is thus highly recommended you work with vendors who do obtain their own insurance, even if they are not legally obligated to do so. This not only helps establish their status, but protects you from injury lawsuits. Important to note that you should get a certificate from every vendor, regardless of status as sole proprietor or corporation.
- As much independence as possible should be given in areas such as hours worked, where the job is to be performed, etc. Keep emailed communications on file showing that the vendor has made their own decisions about schedule and work location. A vendor must show complete autonomy/sovereignty. An email that says "I have room in my schedule to come in Friday of this week and hold a casting call at your location" is the sort of thing you'd want to print and keep. Also "I'd prefer to assemble to pieces on site at your office, so expect delivery of materials Thursday, and I'll be in Friday to inspect."
- The person should provide his/her own tools, supplies training, transportation, etc. This really depends on what is outlined in the contract, and what your industry norm is. It is important to clearly reflect how equipment will be handled, in your contract. For instance, fashion stylists tend to rent certain kits which include a steamer, iron, sewing tools, etc. which are included in their final invoice as reimbursable expenses. This is a different from a plumber who normally would arrive with a full toolbox of typical tools used for repairs. Consider what your industry usually expects from a vendor of this type. It is also unrealistic to think that someone who does bookkeeping would bring a computer, printer, fax machine, etc to your office for performing an audit when you already have such equipment available.
- Is the worker required to comply with instructions about when, where and how the work is done? The vendor should not be instructed in any way as to how to perform the work. [i.e. a photo assistant should already know how to use cameras and light meters; a graphic designer should already be familiar with software; a fashion stylist should have resources to pull clothing]. The vendor cannot be instructed where to perform the work. [i.e. a graphic designer should be free to work from their own office]. In the case of photo shoots of course all crew must arrive when the call sheet states, but this does not qualify as being forced to work in an employer's location, rather there is a "project site". The vendor must be left to his/her own devices to perform the task, unsupervised.
- Is the worker provided training that would enable him/her to perform a job in a particular method or manner? The vendor should not be trained in any way or give special instructions. This is different from "orientation". It's expected you might have to show someone where certain office equipment is kept, layout of an office, how to operate phones in case a call is for him/her. This is not training as you are not showing the vendor how to do his/her job, merely making it easier for them to perform the service without unnecessary problems.
- Are the services provided by the worker an integral part of the business' operations?The vendor should provide a service that is not a regular service provided by anyone else on staff, and preferably something that the hiring company does not do as part of business. [i.e. a fashion designer hires a plumber to fix office kitchen sink, a photographer hires a copywriter to help enhance his website]. Roles that would appear suspicious are hiring a secretary, office manager, executive assistant and claiming that person is an independent contractor. These are not "specialized" services and most companies would require someone in these roles on a regular basis, not just once in a while.
- Must the services be rendered personally? An independent contractor should be able to use whatever means necessary to provide the service. This could mean using a subcontractor or other workers to get the job done. There should be no control over who/how the contractor completes the task. [i.e. a carpenter should be able to determine whether an apprentice can be utilized for a particular task, an accountant can use a junior accountant to do bank reconciliations]. Much of this would be outlined clearly in a contract.
- Does the business hire, supervise, or pay assistants to help the worker on the job? The contractors subcontractors should never be paid directly, negotiated with or supervised. That is all the role of the independent contractor to do. [i.e you should not pay photography assistants, a carpenter's apprentice, or a junior accountant directly]
- Is there a continuing relationship between the worker and the person for whom the services are performed? While it is expected that a company would use a contractor again if they were satisfied with services, continued regular frequent use would appear suspicious. [i.e. you use an professional office organizer to review your office procedures and come up with a streamlined way for staff to file paperwork, but now you use that person to do all filing themselves on a daily basis for three hours a day]. You don't want to have a vendor who visits regularly and whose job can be done by regular office staff.
- Does the recipient of the services set the work schedule? The vendor must be the one to initiate and determine the schedule. Of course if your office is not open on the particular day the vendor chooses, negotiations are in order. It's a good idea to keep emails from your vendor indicating clearly that they are selecting the schedule themselves.
- Is the worker required to devote his/her full time to the person he/she performs services for? The vendor should determine when and how much time he/she devotes to handling the task. You cannot require the vendor to work full time on your project; he/she is free to work on other projects for other clients.
- Is the work performed at the place of business of the company or at specific places set by the company? It is preferable that work be done from the office of your vendor, but it is acceptable for the work to be done on your premises if it can be justified. Justification would mean it was for the benefit of the vendor to make completing the task easier. [i.e. a bookkeeper working on premises because the financial documents are all located at the client's office; a carpenter building cabinetry on site instead of offsite and then having to truck it in]
- Does the recipient of the services direct the sequence in which the work must be done? You cannot supervise or determine what sequence a vendor completes the work. [i.e. if a casting director chooses to hold a casting call for kids before he does one for adults, it's not your place to tell him/her to do it another way]
- Are regular oral or written reports required to be submitted by the worker? You cannot require progress reports or schedules from the vendor. This is different from phase completions, which have milestones to be met. [i.e. web site designers usually break projects into phases, and the projects move forward based on client approval of work complete in the prior phase]
- Is the method of payment hourly, weekly, monthly (as opposed to commission or by the job?) While it is not really a problem if you pay a vendor hourly, weekly, or monthly, the payment periods must reflect information to match what the contract outlined. You cannot appear to pay a vendor like an employee. [i.e. your vendor charges $25 an hour to repair office telephone equipment, as outlined in contract, and invoices you at the end of the work for total hours worked; a prop stylist charges a total of $5,000 for 1 prep/2 shoot days as determined in your deal memo]. It is better to pay by total contract, rather than interim payments, but in many cases this cannot be feasible. Most importantly, it has to be determined by the vendor and stated in contract.
- Are business and/or traveling expenses reimbursed? You should not reimburse a vendor for any overhead expenses they incur as the cost of doing business. [i.e no reimbursement for meals, subway transport, cell phone use] However, reimbursements for materials purchase on your behalf is acceptable if this is outlined in contract. [i.e. props purchased for a photo shoot, or software purchased for your office by an IT professional]
- Does the company furnish tools and materials used by the worker? The vendor should supply their own equipment, within reason. You'd fully expect a plumber or electrician to show up with a tool box. However, if a vendor is a graphic designer or bookkper, if you have the same equipment and software on your premises, the vendor can use it if it is for the convenience of the vendor. As long as you have not forced the vendor to use your own equipment, it's acceptable.
- Has the worker failed to invest in equipment or facilities used to provide the services? The vendor should have equipment and facilities appropriate for the work they provide, even if they choose to use yours occasionally. [i.e. a fashion stylist should either own or rent a steamer; a graphic designer should own a computer and printer]
- Does the arrangement put the person in a position or realizing either a profit or loss on the work? The vendor should be at risk of taking a loss. This means they earn income from their services and have business expenses. Either they will make a profit or show a loss when filing taxes. [i.e. an individual sole proprietor files a Schedule C showing profit & loss from business when filing their annual tax return]
- Does the worker perform services exclusively for the company rather than working for a number of companies at the same time? The vendor's services should be utilized by several other clients, not just you. While you might not have control over what that vendor decides to do with their marketing, it is highly unlikely a vendor in business for themselves would choose to work ONLY for you. That would appear suspicious particularly since it would mean that most of their time is spent doing work for you, which could be considered regular employment. It's a good idea to obtain updated client lists from vendors, or print information from their websites.
- Does the worker in fact make his/her services regularly available to the general public? It is important that the vendor market their services. Materials that would prove this are a professional website, business profile on social network sites, business cards, postcard or brochures, display ads, a listing in a business phone directory. If someone does not have any proof of advertising, and works solely for your company, it is unlikely they are an independent contractor, as they are spending most of their time working for you.
- Is the worker subject to dismissal for reasons other than non-performance of the contract specifications? The only way that a relationship with a vendor would be terminated is due to failure to perform what the contract states. You cannot "dismiss" or "fire" a vendor for doing something like "showing up late", "ignoring dress code", or "taking too many sick days". Such things are employee related issues. There should not be rules a vendor has to adhere to. Of course, totally illegal things like sexual harassment, theft, etc. would definitely terminate a contract.
- Can the worker terminate his/her relationship without incurring a liability for failure to complete the job? If a vendor fails to perform the service outlined in a contract, the vendor is at risk of course of not being paid, or for being subject of a lawsuit for subsequent damages, so there is a liability for breach of contract. If an employee quits a job, there is no liability incurred, unless there was a employment contract.
- An independent contractor must receive and file 1099MISC income forms (if over $600)
- Similar workers must be treated alike (not treated as employees). So if you enlist the help of an outside bookkeeper as an independent contractor, yet you already have several bookkeepers on staff as employees, this new bookkeeper cannot be considered an independent contractor and must be placed on payroll.
- There must be a good reason for the contractor status
a) Precedent: court cases and revenue rulings showing that another vendor very similar to your vendor was determined to be an independent contractor
b) Practice: long standing in the industry. If your industry standard has been that vendors similar to your vendor have always been treated as independent contractors, then your vendor can be confirmed as independent. [i.e. if you use acting extras for background filler for television commercials, and everyone in your industry has usually paid them as independent contractors, this will remain the same]
c) IRS previous audit. If you've been audited by the IRS before and certain vendors were accepted as independent contractors, they cannot be considered employees later on if nothing about the nature of their work or relationship to you has changed.
The ultimate safeguard is to complete a Form SS-8 which asks the IRS for a determination if the person is an employee.
Understand that all I have written here is assuming that the vendor is indeed an independent contractor. If you have someone working for you who clearly is an employee that you are trying to classify as a vendor to avoid payroll taxes or insurance, you will most likely lose your argument. My recommendation is to review all your vendor files, ensure paperwork is current and complete, review vendors who you feel might straddle the fence between vendor vs. employee and clearly determine what their status is. Then do the right thing if they should be considered an employee. Focus + Finance strongly supports the rights of workers, and equally the rights of our clients. Contact us if you'd like a review of your current procedures, are undergoing an audit, or have labor problems. Although our specialty is bookkeeping, we extend our services to assist clients who find themselves drowning in unfortunate labor and insurance issues. We urge you to seek out legal assistance first and foremost before you take next steps, and are happy to liaison with your lawyer.
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