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Independent Contractors vs. Employees: How Much is Your Agency at Risk?

Jeffrey Frisch, CPA
07.24.2017 | Berdon Industry Insights

Has your agency been audited lately for misclassification of employees as independent contractors? If so, you know what a hassle that can be both monetarily and timewise. If not, how vulnerable would your company be if it eventually was selected for an audit? As federal and state governments continue to look for ways to increase revenues and ensure that certain workers are protected by employment laws, ad agencies, PR firms, and other marketing-related businesses continue to be audited for the misclassification of employees as independent contractors.

The Benefits of Utilizing Freelancers

Of course there are many business and economic reasons why agencies prefer using freelancers. Generally, this industry is project-based and freelancers can be used to balance the ebbs and flows of staffing needs. In addition, many companies use individuals or teams of freelancers on a trial basis as a way of assessing whether or not they should be hired full-time. The trial period can last days, weeks, or even months. Since these businesses use highly creative copywriters, art directors, and graphic designers, in addition to other positions, many times these sought-after talents will dictate that they will only work on a freelance basis. When using independent contractors instead of employees, companies can save financially by not having to pay:

  • Social Security and Medicare matching contributions
  • Unemployment insurance and other taxes
  • 401(k) and other pension contributions
  • Medical premiums
  • Overtime, sick, holiday and vacation pay
  • Other work-related expenses

Gauging Your Risk

It is essential for industry executives to ask themselves if the risk and ramifications of an audit outweigh the above-mentioned advantages. In most cases the answer is NO. Although it makes sense to employ the occasional freelancer, it is advised that companies take steps to make sure that if they do get audited, the risk of the government reclassifying their independent contractors is low. These steps will limit the amount of time spent on the audit, avoid having to go back and refile payroll tax returns for prior periods, and most importantly save the business from additional taxes, interest, penalties and, in some cases, even federal and state withholding tax, all of which could be substantial.

The correct classification of staff is not always straightforward. Determining whether a worker is an employee or independent contractor under federal or state law is highly fact-specific. The IRS has developed a 20-factor “test” to help guide employers. These factors are broken down into three areas — behavioral control, financial control, and relationship of the parties. There is no objective measure that says an agency needs to comply with a certain percentage of the 20 factors — it’s a more subjective measure. In general, the more a company controls where the work is performed, the supervision of the work, those working on the project, the hours of the day when work is completed, and the equipment being used to perform the work, the greater the likelihood the staffing relationship would be deemed an employer/employee relationship rather than a company/freelancer one.

Protecting Your Agency

If your agency determines it must continue to utilize freelancers, even in a limited capacity, the following provides some helpful hints of what to do and what not to do:

  • Do not include them on your website.
  • Do not give them a job title.
  • Do not issue them business cards or a phone extension.
  • Do not let them submit timesheets in order to get paid. The true freelancer should submit an invoice and only be reimbursed for some, but not all of their out-of-pocket expenses.
  • Do have a contract with a fixed end date to help demonstrate the nature of the freelance relationship.

As an employer, it pays to be extra diligent about the freelance arrangement from the outset of the assignment. Keep in mind, there are many people who insist on being hired on a freelance basis and then claim they were an employee and file for unemployment benefits when they are no longer needed by the company. In fact, this situation may often be the catalyst of an independent contractor vs. employee audit.

Given how gray an area this topic is, if you have any questions such as, how to classify or reclassify workers, or if you need help with an existing audit, please contact Jeffrey Frisch, CPA at jfrisch@berdonllp.com.

To view a recent video that provides additional details on this industry topic, click here.

Berdon LLP, New York Accountants

Origional publication date March 16, 2017