The business model for independent brokerage firms is under threat, calling into question the livelihood of over 178,000 registered representatives.

Currently independent brokerage firms pay reps on an independent contractor basis, allowing them the independence of working for themselves. But legislation that was introduced to the House in late July by Rep. Jim McDermott (D-Wash) and to the Senate in December by Sen. John Kerry could lead to high costs and extra hassle for independent broker-dealers.

The legislation titled the Taxpayer Responsibility, Accountability, and Consistency Act of 2009 would remove the safe harbor provision in Section 530 of the Revenue Act of 1978, which could force independent broker-dealers to reclassify independent financial advisors as employees, subjecting the firms to back taxes, penalties and interest.

Dale E. Brown, the president and chief executive officer of the Financial Services Institute, a membership group which represents 118 independent broker-dealer firms, said in an interview Tuesday that although FSI supports the goals of the legislation to correct abuses in independent contractor classification, the concern is that the financial advisory community gets caught in the unintended consequences.

“The independent broker-dealers and the independent contractors they license have a three decade record of compliance with applicable rules so there is no need for the IRS to be given any reason to question whether or not our industry is appropriately classified,” he said. “We are an extremely regulated industry. There are no cash transactions so everything is highly auditable and t ax compliance is not an issue.”

The Financial Services Institute is also worried that if the Internal Revenue Service succeeds in forcing independent broker-dealers to reclassify their advisors as employees instead of independent contractors, the excess cost would shatter their business model and take away a lot of their independence.

“Our business model is unique because instead of advisors being employees they are self-employed and own their own advisory business,” Brown said. “They decide what hours they will work, they rent their own office space, hire their own staff, and assume all the risk of being a business owner. This legislation would pull the rug out from under one of the foundations of our business model.”

If independent broker-dealers go out of business or are hindered in their ability to compete because of rising costs that would mean less access to affordable financial advice for Main Street, Brown said.  

But a press release on Kerry’s website states that the legislation will “provide workers with the rights they deserve” and says that the “current tax loophole, which allows employers to misclassify some workers as “independent contractors,” denies employees valuable rights and protections.”

The legislation will ensure that workers’ compensation, Social Security, Medicare, overtime, unemployment compensation, and the minimum wage are offered to all employees, the press release stated.