Payroll taxes. Benefits. Worker’s compensation. I know, i know. Heavy stuff, but read on, because it may save you the hassle of back taxes and potential lawsuits. If you own a small business, you are probably familiar with the idea of working with independent contractors rather than hiring employees. It’s a popular option for many small businesses, particularly because having independent contractors means generally less expenses for the business owner. You don’t have to provide health insurance, paid vacation time, worker’s compensation, and the biggie-you don’t have the hassle and expense of payroll taxes.
Sounds simple, right? Just work with independent contractors and never hire employees. Tell the people that they are not employees, they are independent contractors, and that’s that. Right?
Wrong. Merely titling someone as an independent contractor does not make it so. Rather, the worker’s job must meet certain guidelines in order to qualify for that classification. If you incorrectly call someone an independent contractor when they really should be classified as an employee, you can be liable for back-taxes on that worker and potentially face liability in related lawsuits.
In order to avoid those pitfalls, here are some general guidelines for determining a worker’s classification as an independent contractor or employee.
1. Behavioral Control. If the employer has the right to control how, when, and where the work is done, the worker is likely an employee. For example, an employer might tell the worker that she needs to wear a uniform, report to work at eight in the morning, and stand at the door greeting customers as they enter the store. The more control the employer has, the more likely the worker should be classified as an employee.
2. Financial Control. The more financial control the employer has, the more likely the worker should be classified as an employee. For example, payment of the worker by the hour, week, or month – rather than by completion of a job – points to employee status. If the worker is reimbursed for expenses, such as travel expenses or purchasing work-related equipment, this also points to employee status. On the other hand, a worker who has a significant investment in his work, such as office space and materials that he pays for individually, leans more toward classification as an independent contractor.
3. Relationship of the Parties. If the employer provides benefits, such as health insurance and paid vacation, the worker is likely an employee. Also, if both parties retain the right to terminate the relationship – to fire the worker or to quit the job – that points to employee classification. An independent contractor must generally complete the job and is not free to quit.
Purposefully classifying someone wrongly can cost you dearly in irs penalty fees, so please play by the rules. Of course, each individual situation is nuanced, and these are just some general guidelines. More information, including a list of twenty factors to consider for classification, is available through the internal revenue service. So check out irs.gov, or consult with a qualified attorney, if you have additional questions.