After the complaint, an owner may receive Form SS8, which embodies the so-called 20 common law factors used to classify workers — as employees paid under a W-2 form or as contractors paid on a 1099 form. (This applies to all workers, not just installers; however, there are special laws pertaining to workers such as sales reps.) If you complete this form, says Berenson, “you’ll lynch yourself.” Instead, contact a tax attorney or someone well-versed in these issues and have him or her prepare a position paper and do a pre-audit analysis to determine a course of action. “If you have a defensible position, your attorney needs to make that defensible position to the IRS,” Berenson says. “You want to try to nip this in the bud and not trigger a complete audit.”
Unfortunately for Peters, who contacted both his CPA and his attorney (not a tax attorney), the IRS began an audit, delving into two years of records. Not only did the IRS interview the original complainant, it spoke with all of Peters’ subs and employees, “including Texas-based wall and truss crews, some of whom had 15 to 20 employees of their own,” he says. The verdict: Peters owed $426,000 in withholdings, penalties, and fines.
Once the reclassification process begins, it’s a bit late to build up a defensive wall, Berenson says. Ideally, you want to be proactive. There are a number of protocols and procedures you can put in place to guard against a reclassification audit. The three most important are:
- Installers must be under a written agreement setting forth their understanding of the tax relationship they have with the company. The agreement should clearly state that the person is an independent contractor who will file his or her own taxes and has no right to have monies such as Social Security withheld.
- The installer should be hired as an entity, not as an individual. “When a field agent reviews your payroll, they’ll pull things made payable to Johnny Jones. There’s a good chance that if the 1099 is made payable to Jones Installation Inc., they won’t pull it,” Berenson says.
- Make sure the installer carries insurance (workers’ compensation, auto, liability, etc.), and, if you’re in a state that requires licensing, make sure they have that too.
“There are other bricks you can put in a defensive wall, such as how you handle distribution memos, or tools and trucks,” Berenson says. “But if you have these three foundation bricks you’ve gone a long way toward protecting yourself.”
Peters’ story has a relatively happy ending. For reasons he can only speculate, the case closed without him having to pay anything (except attorney fees), even for the one worker who was clearly misclassified. “But for a whole year I felt exposed. I was frightened,” he says. “The tension and stress were unbearable.”
Not long after, Peters dissolved his business and moved to another state. He now owns a successful small remodeling company, and he has built up his wall of defense. “We don’t employ anybody as a sub unless they can provide a certificate of insurance. He has to be able to prove he works for other contractors and not just for me. A one-man show like a wallpaper hanger has to sign a four-page form in which he attests to the fact that he sets his own hours and all the other things the IRS asks for,” Peters says. “All it takes is one time for someone to complain. It can turn your world upside down.”