You’re probably sick of all the talk about the Greek bailout by now, but I’m fascinated by it—not just because I studied macroeconomics in college but also because of a particular reason behind Greece’s financial troubles. It’s this: If Greece were able to collect all the taxes its citizens should have been paying, it could pay off 80% of the bailout money it has borrowed.

Tax avoidance isn’t a problem in Greece alone, though. Estimates indicate America’s underground economy is so big it would generate $1 trillion worth of new tax payments. And as we all know, non-payment of taxes in the construction industry is rampant. I’ve heard remodelers around the country say things like, “I know John Doe should be an employee, but he doesn’t want to be taxed.” What this really means is “I don’t want to pay all those taxes on John Doe’s behalf.”

Ultimately, Greece must come to account with its tax cheats. In the United States, we’ve seen mounting evidence that the federal government is going after companies that it believes avoids taxes, worker’s compensation, and liability costs by treating people as independent sub contractors rather than as employees.

Answering the sub-vs.-employee question has always required a judgment call, and until recently the determining factors have involved the amount of control a contractor had over the sub and that amount of control a contractor had over his own decisions. But recently, the administrator of the Wage and Hour Division in the U.S. Department of Labor issued a memorandum that analysts say puts more emphasis on the sub’s economic independence. In essence, the more that subcontractor relies on you for his living, the harder it will be for you to prove he’s independent.

Meanwhile, the IRS is increasing its audits of contractors with 1099 classifications in its crosshairs. Protect yourself now!

Four years ago, attorney and accounting professor Barry Leibowicz wrote an essay saying an employee has these characteristics:

  • Is paid by the hour/week/month/year
  • Works only for you
  • Is reimbursed for business expenses such as mileage and cell phone use
  • Is trained or monitored by someone in the company
  • Provides oral or written reports

And Leibowicz said an independent contractor shows these traits:

  • Is paid by the job and can suffer a profit/loss based on the job bid
  • Makes his/her work available to the general public
    Incurs business expenses not related to work on YOUR job but in running a company
  • Is responsible for own training
  • Has a periodic relationship with you

In summary, Leibowicz says, “When a worker determines means, manner, and time of performance, in the context of a relationship where he can either profit or lose money in the process, any job, regardless of how complex or menial, can be performed by an independent contractor.” [emphasis mine]

So, how to protect yourself from the potential liabilities of incorrectly classifying an independent contractor this year?

  1. Set up an alphabetical file into which you’ll place all vendor 1099 information
  2. List all potential independent contractors whom you have paid $600 or more (1099 dollars are based on payments made) in 2015 and who are not incorporated—except for lawyers: talk to your accountant about this
  3. Determine the basis on which this payee has been classified as an independent contractor
  4. Send the list, together with the basis for determination, to your accountant for their review and sign-off: this protects you in case of audit
  5. Secure the payee’s Taxpayer ID Number (TIN) by requesting a completed W-9 form. At the same time you might send a letter notifying them of the IRS increased scrutiny of independent contractor classifications—you’d be doing them a favor as well.
  6. Secure the payee’s workers comp and general liability insurance certificates, if applicable. If not applicable, include a letter or email in the alphabetical file clarifying why this payee was not responsible for these insurances.

Don’t be like Greece—pay the taxes you owe, not a penny more, and don’t get caught paying taxes plus penalties on behalf of workers who don’t!