At MBO, we are hearing of more and more companies being audited for hiring independent contractors (a.k.a. 1099s, single shingles, Sole Ps). It seems like a great idea at first; states are sharply raising the SUTA (State Unemployment Tax Authority) tax rates on businesses. How do you avoid unemployment tax? Move your workers into independent arrangements on 1099s! Sounds simple, right?
If that method ever worked in the past, it certainly won’t work anymore. Many states are broke and desperate from the economic downturn that started back in 2007. Nearly half of the states’ unemployment benefit coffers are depleted, forcing them to borrow from the Federal Unemployment Trust Fund. In fact, as of January 4, 2013, nineteen states have amassed loan balances of more than $27 billion in their Trust Fund accounts. The January interest alone is more than $215 million. How are the states dealing with this budgetary crisis? They are increasing their focus on enforcement, which means a steep rise in audit risk for companies using 1099s.
Prominent executives are telling us that the audit trigger can be caused by a single ex-1099 filing for unemployment. Usually the client is able to fight the claim, but by then the damage has already been done. Because employers pay FUTA and SUTA taxes for an employee and don’t have to for a 1099, an unemployment claim can give the appearance that a company used 1099 status to avoid paying unemployment taxes. Once on the radar of the state tax authorities, it is not uncommon for other agencies, including the Department of Labor and the IRS, to initiate their own audits. In addition, companies open themselves up to class-action lawsuits for overtime, stock options, pension plans and other fringe benefits not provided to 1099s.
To protect yourself, it’s important to employ risk mitigation techniques and put an independent contractor governance program in place that takes into account the various state criteria for proper classification (not simply focusing on the more well-known IRS three-factor test). It is important that the company you hire has a proven track record and takes all of the risks into account or you could find yourself on the wrong end of an audit or lawsuit.
If you would like learn more about independent contractor/1099 risk mitigation and engagement best practices put in place at more than forty Fortune 500 companies, please contact us above.
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