Independent Contractors

Independent Contractor factors explained

From QuickBooks website, July 16, 2015

Regardless of the industry or size of the business, employers are responsible for the correct classification of their workers. Failure to correctly classify a worker as an employee or independent contractor can make the mistaken employer responsible not only for the worker’s back employment taxes, but also penalties, warns the IRS.

And the IRS is cracking down on employers who misclassify workers and don’t pay their fair share of employment taxes. Therefore, it’s crucial for small business owners to understand how a W-2 employee differs from a 1099 independent contractor.

A number of factors go into worker classification for tax purposes, and pursuant to IRS Publication 15-A, they fall into three broad categories: behavioral control, financial control, and relationship of the parties.

It’s important to note that no single factor stands alone in making the worker classification determination; all factors together must be considered in order to make the proper classification.

1) Behavioral Control – As a small business owner, if you provide extensive instructions on how your work is to be carried out and training on required work methods and procedures, then the IRS will suggest that an employer/employee relationship exists. Detailed work instructions may include how and where the work will take place, what equipment to use, and where to purchase supplies and equipment. Similarly, if you want the job to be carried out in a certain way, and provide training to this effect, you’re likely hiring an employee, not an independent contractor.

2) Financial Control – Three factors come into play when determining whether you have financial control over an individual: significant investment, expenses, and opportunity for profit and loss.

Significant investment – While there is no specified dollar amount, if your worker has to make a significant investment in order to work, he may be an 1099 independent contractor vs. an employee.
Expenses – If you don’t reimburse your worker for some or all of his businesses expenses, then this suggests that he is an independent contractor.
Profit or Loss Opportunity – If your worker has the opportunity to incur a loss or realize a profit, then she may be in business for herself, suggesting an independent contractor status.
3) Relationship – Factors that illustrate how the small business owner and worker perceive the relationship include presence of employee benefits and information included in a written contract. For instance, if you provide your worker with insurance, a pension, and paid time off, then the IRS may say this signifies an employer/employee relationship. If other facts or circumstances surrounding the relationship aren’t conclusive for worker classification purposes, a written contract often is. The written contract should clearly detail what you, as the business owner, intend to get out of the business relationship.

Conclusion: Take time now to review each worker in your small business to determine if they are classified correctly, and make sure new hires are brought onboard with the proper classification. It’s also a good idea to seek guidance from an human resource professional or employment law attorney.

Additionally, both the small business employer and the worker can ask the IRS directly to make a worker classification determination by completing and filing with the IRS Form SS-8: Determination of Worker Status for Purposes of Federal Employment Taxes and Income Tax Withholding.

 

Hiring an Independent Contractor?

This is good information by a SCORE Volunteer and retired attorney

By Chuck Harris Score Volunteer and retired attorney 

If you’re in business for yourself and find you need additional help, a prudent first step may be to consider hiring independent contractors rather than employees.

Independent contractors work for themselves and perform their services on their schedule rather than yours. In such arrangements, you are the independent contractor’s customer, not their employer, which means you don’t generally withhold taxes from their payments or pay their Social Security or Medicare.

In addition, independent contractors use their own resources to do the job, whether it’s tools, technology, or people. The independent contractor is also responsible for his or her incremental expenses, including transportation, routine purchases, as well as time and materials above and beyond their estimate.

It is advisable to prepare a written agreement that spells out the independent contractor relationship. Depending on how you manage the working arrangement, the difference between an independent contractor and employee can easily be blurred to the point where he or she may be considered your employee under federal and state law. That would then make you an employer, responsible for those payment withholdings as well as penalties and other obligations.

Generally speaking, if you have the right to control or direct not only what is to be done, but also how it is to be done, then your workers are most likely employees. On the other hand, if you can direct or control only the result of the work done — and not the means or methods of accomplishing the result — then your workers are probably independent contractors.

These steps can help prevent an independent contractor from being classified as an employee:

  • Specify the task and contractor’s responsibilities/expectations in the contract.
    n Avoid setting a pattern of daily or weekly work hours dictated by your business.
  • Compensate contractors on a per-job basis, not weekly or monthly.
  • Do not include independent contractors under any insurance or benefits coverage.
  • Always require an invoice before making payment.
  • If you’re still uncertain as to whether your worker is a contractor or employee, IRS Form SS-8, “Determination of Worker Status for Purposes of Federal Employment Taxes and Income Tax Withholding” can be filed with the IRS by either you or the worker. The IRS will review the facts and circumstances and determine the worker’s status.

EMPLOYER ALERT – DOL AND IRS CRACK DOWN ON INDEPENDENT CONTRACTOR VS EMPLOYEE CLASSIFICATIONS

The IRS and the Department of Labor (DOL) are working together conducting random audits of companies looking for workers who have been improperly classified as independent contractors instead of employees. In 2011, the DOL hired an additional 250 investigators to conduct audits.

The IRS goal is to raise additional tax dollars, since employers do not withhold income taxes or FICA from independent contractors. The DOL goal is to require companies to pay improperly classified workers back pay for all overtime that would have been due if they were classified as employees. The consequence can be economically disastrous for your business, in terms of back overtime, liquidated damages, penalties, and tax liability. In addition, the improper classification of workers as independent contractors instead of employees has implications in unemployment compensation and workers compensation.

One of the red flags to both agencies is an employer who reclassified a group of workers during the year, resulting in issuance of both a W-2 and a 1099 to the same worker for performing, basically, the same services. If your company has made a decision to reclassify workers as a cost-saving measure, make sure those workers can legitimately be hired as independent contractors under the law, or the cost-cutting effort may backfire.

Both the IRS and the DOL look at the following factors.

How closely do you supervise and instruct the worker? Workers who must comply with your instructions as to when, where, and how they work are more likely to be employees than independent contractors. It’s the difference between telling them what to do, and telling them how to do it.

Do you control the hours of work? Although there are situations when the work by its nature must be performed at a certain time or in a certain sequence, in general workers for whom you establish set hours of work are more likely employees. In contrast, independent contractors generally can set their own work hours. Also, an independent contractor usually doesn’t work for you full-time, although there are exceptions.

Do you provide training or did the worker obtain specialized knowledge from outside your business? The more training your workers receive from you, the more likely it is that they’re employees. The underlying concept here is that independent contractors are supposed to know how to do their work and, thus, shouldn’t require training from the purchasers of their services.

Where does the worker fit in your organization? The more important the worker’s services are to your business’s success, the more likely it is that they’re employees.

Does the worker need to perform the services personally? Workers who must personally perform the services for which you’re paying are more likely employees. In contrast, independent contractors usually have the right to substitute other people’s services for their own in fulfilling their contracts. Also, workers who are not in charge of hiring, supervising, and paying their own assistants are more likely employees.

Is the worker performing a specific project with an expected end-date, or do they provide continuing services? Workers who perform work for you for significant periods of time or at recurring intervals are more likely employees. Someone brought onboard for a particular project is more likely to be an independent contractor.

Where is the work performed? Workers who work at your premises or at a place you designate are more likely employees. In contrast, independent contractors usually have their own place of business where they can do their work for you.

Is the worker paid by the hour or by the job? Although there are exceptions, most independent contractors are paid by the job, not by the hour.

Who pays for expenses? Workers whose business and travel expenses are paid by the company are more likely employees. In contrast, independent contractors are usually expected to cover their own overhead expenses, as they factor it into their total charge as a cost of doing business.

Are you providing the tools and equipment? Workers whose tools, materials, and other equipment you furnish are more likely employees. Independent contractors, by contrast, usually have their own tools and equipment.

Does the worker have an investment in his or her business and the opportunity for profit or loss? The greater the worker’s investment in the facilities and equipment they use in performing their services, the more likely it is that they’re independent contractors. Similarly, the greater the risk the worker takes of either making a profit of suffering a loss in rendering their services, the more likely it is that they’re independent contractors.

Do they work for more than one client? The more businesses for which your workers perform services at the same time, the more likely it is that they’re independent contractors. Workers who hold their services out to the general public (for example, through business cards, advertisements, and promotional items) are more likely independent contractors. By contrast, an individual who works exclusively for your company is more likely an employee.

Are there restrictions on your right to fire the worker, or the worker’s right to quit? Workers whom you can fire at any time are more likely employees. In contrast, your right to terminate an independent contractor is generally limited by specific contract terms. Likewise, an independent contractor who has signed a contract to perform a specific project for your company will be in breach of contract if they abandon the project. An employee, however, is generally free to resign at any time.

Remember, no single one of these factors is determinative. The DOL and the IRS look at the combination of factors to determine whether the relationship is an employment relationship or an independent contractor relationship. How these factors are weighed can also vary based upon the specific type of business or industry.