Independent contractor tricky, costly arrangement

The Bakersfield Californian
September 13, 2013

Being a financial advisor doesn’t always mean focusing just on “dollars and cents.” Sometimes it requires focusing on a client’s financial strategy to ensure it makes sense.

Recently a young woman entered my office to discuss the changed circumstance of her employment. She and her husband have been my clients for about two years, with most of our attention directed toward coordinating her employer-provided 401k tax-deferred savings plan with the couple’s other assets.

The woman recently had a baby. Although she wants to continue her career, she does not want to leave her baby with a sitter. Her solution: She becomes an “independent contractor” for her former employer. Working primarily from home, she will provide basically the same services and have nearly all the same work-related responsibilities that she had as a full-time employee.

While this arrangement may seem to be simple, it can be loaded with many financial and legal traps for both the employer and the employee.

During the Great Recession of 2008-2011, the federal Internal Revenue Service, as well as federal and state employment and labor agencies began cracking down on companies’ use of “independent contractors.” Hoping to cut costs by avoiding the payment of “payroll taxes,” such as Social Security, Worker’s Comp, etc., companies were converting fulltime employees to “independent contractor” status.

But often these “independent contractors” arrangements were mere shams. Employees continued to have company offices; used company equipment, such as computers; and were contacted through company telephone numbers and email addresses. Their responsibilities remained the same, and they had little flexibility over their work schedules and assignments.

Companies that are found to be abusing the “independent contractor” arrangement can face significant fines and legal penalties. As Obamacare kicks in, the IRS has vowed to increase its scrutiny of these arrangements. Employers will have to exercise greater care.

From my client’s description, her former employer is skirting close to the IRS definition line – and likely crossing it – in its treatment of “independent contractors.”

And while my client seems to be focusing on the short-term resolution of her child care needs and celebrating her ability to continue bringing in a “hefty salary,” she seems to be overlooking the costs and risks her employer has shifted to her shoulders. Among the things she now has to pay are: both the employer’s and employee’s share of Social Security; her taxes; liability insurance; fees for a local business license and home occupational permit; and a variety of other costs associated with operating a home office.

I suggested my client consult with her attorney and accountant regarding the specifics of her independent contractor arrangement. For a start, she should insist on a written contract to cover what is now a verbal arrangement. The contract should delineate her work and financial responsibilities.

But she also must become more focused and disciplined when it comes to saving for her retirement.

  • Roll her company 401k account over to an IRA or some other tax-deferred device that she and her advisors can manage.
  • Regularly contribute to the new tax-deferred account. This will continue to build retirement savings and reduce my client’s tax liability.