Yes! They Can Audit Your Use of Employees vs. Contractors
Careful classification of workers as employees vs. contractors can protect you from surprising impacts on your tax and workers’ compensation insurance burdens.
By Clay Watson, MPT
Sometimes it seems auditors can fall from the sky, looking to take another bite out of your apple. Audits do not just come from payers—they come from diverse places and at unexpected times. In the spring of 2014 we were audited by our state Division of Workforce Services on the employment status of people who work for us. Things got worse in June when I was audited by my workers’ compensation carrier about the coverage of my staff. Both of these audits highlight potential pitfalls in how we use contractors versus employees in private practice physical therapy.
Employee vs. Contractor Rules
While employment law is a perennial issue within our world and has been written about extensively in Impact magazine, I missed a few things. In case you did too, here is a quick primer on this subject in the human resources section of the Private Practice Section website.1
The common law definition of a contractor states:
A. The worker must be free from direction and control in the performance of the service, both under the contract of hire and in fact (essentially, this is the common law definition); and
B. The worker’s services must be performed either
- (1) Outside the usual course of the employer’s business, or
- (2) Outside all of the employer’s places of business; and
C. The worker must be customarily engaged in an independently established trade, occupation, profession, or business of the same nature as the service being provided.
I have a home health staffing service, providing physical therapy, occupational therapy, and speech and language pathology services across our region’s several counties. We supply labor to home health companies on a contract basis and use contractors for 80 percent of our work. These clinicians perform their labor in patients’ homes—far away from any “direction or control,” and mostly on a part-time basis. I felt like I was in the clear based on this definition alone.
When the audit began, I dug into the Impact archives and found an excellent 2009 article on this topic by Paul Welk, PT, JD.2 He goes much deeper into the rules, clarifying behavior that will place a clinician in one category or the other. In addition, he focuses on who pays which kind of tax, saying that, “Employers withhold income taxes, withhold and pay Social Security and Medicare taxes, and pay unemployment tax on wages that are paid to an employee.”2 Contractors pay their own versions of these taxes but have control over documenting their expenses as they formulate their tax burden. Still, I thought I was following the law.
Look up your state’s version of the rules
Both of these articles focus on the Internal Revenue Service (IRS) guidance on the matter. You would think IRS rules could be respected by all parties. I overlooked the fact that each state has to take their bite. In my case, this came from the Division of Workforce Services (DWS), whose auditors are charged with enforcing state employment law. In other words, collect more unemployment tax. Our auditors took issue with factors that were different from the IRS guidelines:3
- Separate place of business: The worker has a place of business separate from that of the employer. To our auditor, this meant the worker must have their own clinic or another place where they work.
- Other Clients. The worker regularly performs services of the same nature for other customers or clients and is not required to work exclusively for one employer. All of our clinicians worked for other companies, whether as employees or contractors. However, none of them had a separate “place of business” because we see our patients in their home and not in a clinic.
- Licenses. The worker has obtained any required and customary business, trade, or professional licenses. This includes all of us, even the physical therapy assistants and COTAs (Certified Occupational Therapist Assistants).
In the end, we passed almost every issue they raised. This took careful interpretation and patient negotiation. The only workers our auditors would not concede were our physical therapist assistants (PTAs). They felt that since PTAs and COTAs must work under the supervision and direction of a physical therapist, they had to be employees. I had heard this interpretation in the past and preemptively hired any PTAs as part-time employees. Two hundred dollars later we were done.
We thought we were out of the woods and done with audits in May. It turns out though, that DWS and workers’ compensation coordinate their audits. (This audit is different from the annual review with our insurance broker as we evaluate our yearly coverage needs.) And, unfortunately, our local college had a graduating class of accountants in June and our workers’ compensation carrier hired some fresh talent to audit their clients. We were the first audit for our inspector who rigidly set up audit dates that coincided with my family vacation.
In his efforts of severe diligence, the auditor aggressively examined the assigned period as well as the previous year’s data, issuing fines for both years. The findings were again based on our contractor classifications. In our state of Utah, self-employed individuals are not required to carry a workers’ compensation policy. However, if you hire a worker who is self-employed as a contractor, either you must provide workers’ compensation coverage or provide evidence that the worker opted out of coverage. This protects you from getting sued by your workers in either case.
Two days later we had 40 waivers from our contractors for the current year and a plan to require our contractors to pay the state $50 a year going forward to opt out. Unfortunately we only had three or four waivers from the previous year and were fined for the coverage of their payroll.
Who knew the carrier to whom we paid thousands in premiums could go back and fine us for past years’ data? As you can imagine, we had several long, serious conversations with our insurance broker, who was keen on appealing the decision.
Several weeks later we were informed that our carrier forgave the fines with the warning to be more diligent in the future. Diligent enough to not miss the family vacation at the beachside condo in La Jolla, California.
In closing, be sure to follow employment law in your state and with your workers’ compensation carrier—or you may have to face much more than a missed vacation.
1. Independent Contractor or Employee? Resources for Physical Therapist Employers. www.ppsapta.org/c/hr.cfmx. Accessed May 2015.
2. Welk, Paul J, PT, JD, “Bringing on New Staff? Remember the Contractor versus Employee Analysis,” Impact, Feb, 2009, pg. 32, 38.
3. www.irs.gov/Businesses/Small-Businesses-&-Self-Employed/Independent-Contractor-Self-Employed-or-Employee (behavioral, financial and type of relationship of a contractor). Accessed April 2015.
Clay Watson, MPT, is a PPS member and owner of Western Summit Rehab, LLC, in Salt Lake City, Utah. He is also on the PPS Membership Committee. He can be reached at email@example.com.