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Can your company jump through the independent-contractor hoops? A new California law tightens the belt on businesses that use these type of workers.
California is putting the squeeze on independent contractors, some of whom are attempting to avoid their parental responsibilities.
But the companies that employ these contractors are going to feel the pinch.
As of Jan. 1, the state requires any business that files 1099 income taxes to report information about the sole proprietors it hires. The intent of Senate Bill 1358/Assembly Bill 542 is a noble one: to collect unpaid child support. But the result is going to change the rules for California businesses that employ independent contractors, and that includes every mid to large size business in the state, as well as many smaller ones.
It will create additional paperwork, for one thing, and companies could be asked by the state to garnish contractors' paychecks.
Most businesses are not set up to handle these additional requirements, and this will add to the cost of doing business.
How It All Started
The California law's origins can be traced back to 1996, when a federal mandate was enacted to force states to identify employees as of their hiring date, in order to facilitate child support payments. California is now extending that requirement, to include people who get paid on a 1099 basis, rather than just on a W-2 basis.
And there's more than one reason for that. We've monitored the growth of the independent contractor workforce in California, and the problems companies encounter when managing this growth. Our research indicates that as many as 30 percent of California's workers are now so-called "contingent" workers - independent contractors, consultants, etc.
And some of them may have become independent contractors in order to avoid child support.
Recently, one of our clients was a glaring example of this. We use a screening process to ensure that a company's use of its contractors is in compliance with IRS and DOL (and, in California, EDD) regulations. One contractor, however, managed to avoid the screening for two months. When we confronted him, he admitted that he hadn't reported his 1099 income for four years to avoid paying child support.
Senate Bill 1358 may well catch people such as this. But for California businesses, however, it's the latest in a growing line of regulatory hoops to jump through. And it's one more way for an increasingly aggressive EDD to seek out hidden employees.
In addition, there's a frightening body of ignorance out there. Our research suggest that nearly two out of three California companies have no idea that this new law exists. And, among the companies we've surveyed that are aware of the law, three out of four have no plan in place to comply with it.
In California, ignorance will most definitely not prove to be bliss. Believe it or not, we have not found even one sizeable California company that knows how many independent contractors it has. Nor have we found one that knows what it's paying these workers. These companies are heading for trouble: at worst, an audit by a government agency; at the very least, gross inefficiencies in cost-control and effective management of this workforce.
Affecting Many Businesses
Many California companies have large numbers of workers that are classified, for tax purposes, as independent contractors. This lets the contractor claim numerous deductions, and takes the company off the hook for benefits and payroll taxes. But if state and federal agencies determine that these workers are functioning more as employees than as independents, the company can be in real trouble.
Independent contractors, if not carefully scrutinized and tracked, pose risks for the companies that hire them. For one thing, if the state or the Feds find workers classified as contractors, when they really should be classified as employees, the company can be hit with substantial taxes and penalties. In addition, there can be significant benefits exposure; the company's pension plan could possibly be disqualified form its special tax status.
How Costly Can It Be?
Just ask Microsoft, which recently paid out nearly $100 million to settle a case involving its former independent contractors.
And now, with the implementation of SB 1358, there will be increasing reporting requirements for California companies. Accordingly, government agencies will have a much easier time identifying companies with large numbers of workers classified as contractors. It could mean possible audits of the company by the IRS (which loses $20 billion a year due to the misclassification of workers as independent contractors) or the EDD.
This new law makes "identification" a priority. As a result, companies have to institute screening programs, to ensure that people classified as independent contractors really are independent contractors. And it's now become a priority, as well, to build an effective reporting mechanism to comply with the maze of state and federal regulations regarding these workers.
Our research shows that the contingent workforce in California is growing five times faster than the general workforce. Some of the best talent around, especially in fields such as technology, is freelancers.
The challenge for California business is to develop strategies and expertise to use this growing workforce most effectively.
Simply put, you've got to know the new rules of the game. If you don't-and most companies don't- you'd better start thinking about partnering with a firm that does. The stakes are simply too high to do otherwise. Companies such as Microsoft (along with Time Warner, IBM, and Roadway Services, among others) have underestimated the skills needed to manage this process. And it cost them big time.
The good news for companies that use independent contractors is that only four of the 50 states have required this reporting process so far.
The bad news is, we're one of them.
Terrie L. Weinand is Chief Operating Officer of PrO Unlimited, a national consulting and outsourcing firm that helps companies with compliance and management issues. Weinand runs PrO's California operations from its western headquarters in Burlingame. For more information, go to www.prounlimited.com
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