Taking the “easy” way out with 1099 workers can cost you much more than a visit from the IRS.

In the newsletter of April 7th 2012, we again addressed the danger of recruiting workers as 1099 independent contractors.   In doing so we highlighted excerpts from IRS publication 15-A defining how it determines what constitutes an independent contractor vs. an employee.  Many owners in our industry have either inadvertently misclassified their workers as independent contractors or have willfully misclassified their workers.   Either way, they do so at their own peril.

Although the IRS is a federal agency, various states interpret enforcement in their own way.  

Following is a good example of this practice.  This is reproduced from the International Franchise Association’s July 2008 publication of FRANCHISING TODAY:

“Franchisees have also begun bringing lawsuits challenging their independent contractor’s status.  A recent example of this issue occurred in Massachusetts when a janitorial services franchisee operating as a sole proprietor without any employees sought and was awarded unemployment insurance after her franchise failed.  In Coverall North America, Inc. v. Commission of the Division of Unemployment Assistance, the Massachusetts Supreme Judicial Court agreed with the plaintiff that she was an employee and not an independent contractor because Coverall could not prove that the plaintiff could perform janitorial services for any customer wishing to avail itself of cleaning services. 

The court found that “the claimant was required to allow Coverall to negotiate contracts and pricing directly with clients, bill clients, and provide a daily cleaning plan to which the claimant was required to adhere” and therefore not truly “independent.”  Importantly, the court held that it was Coverall’s burden and not the franchisee’s to establish independent contractor status.  This approach, which strongly favors franchisees challenging their status, is sure to encourage further claims by franchisees.”

My point in sharing this info with you is not to discourage anyone from franchising their concept.  Rather, I am doing so to illustrate that if a franchisee – who has clearly entered into a licensing agreement with Coverall, can be reclassified as an “employee” – then no matter of what you call them and regardless of what a written agreement may stipulate,  it should raise one, huge red flag!

Because many California employers have an unprecedented rate classified their workers as “independent contractors” to avoid the costs and expenses associated with payroll, overtime pay, workers’ compensation insurance, disability, and other traditional employee benefits and protections. In addition to defending claims brought by aggrieved workers, businesses operating in California should be aware that the IRS and various state agencies have significantly increased compliance audits to ensure businesses are complying with employment tax laws and withholding requirements.

Here is an update to California’s labor code provisions effective in 2012:

Effective January 1, 2012, Sections 226.8 and 2753 have been added to the California Labor Code authorizing California’s Labor and Workforce Development Agency to assess civil penalties of not less than $5,000 and not more than $15,000 for each violation in addition to those civil penalties already permitted by law. The civil penalties increase to $10,000 and $25,000 for each violation if the Agency determines that the employer has engaged in a pattern, or practice, of willful misclassification of its employees as independent contractors. The new law further authorizes an individual to file a complaint with the Labor Commissioner and the Labor Commissioner to assess the above-mentioned civil penalties against the employer if the Labor Commissioner determines that the employer has in fact misclassified the employee. If the employer is a licensed contractor, the new law further requires the agency to notify the CSLB, and requires the CSLB to initiate its own action against the contractor.”

Frankly, I don’t know what one gains by risking fines (and worse) by trying to avoid related payroll burden expenses.  Yes, there are costs involved when you have employees, but they are miniscule in the greater scheme of things – especially when compared to a penalty of $5,000 to $15,000 misclassified worker!

With 18 years in the cleaning industry and 45 years of experience building his own businesses, Gary Goranson was one of the first business consultants to serve the residential cleaning industry with real experience and solid credentials. Visit him at HouseCleaningBiz101.com.