The biggest mistake small business owners make when hiring staff is misclassifying employees and independent contractors. Hiring independent contractors has a lot of advantages, including saving you money and the hassle of paperwork. You don’t need to worry about withholding income, Social Security, and Medicare taxes or paying unemployment tax on independent contractors’ salaries as you would with employees. You’ll also likely be able to hire more specialized and skilled workers who would be out of your budget if you hired them as full-time employees.
However, problems with the IRS can arise when business owners don’t know where to draw the line on control and financial issues. The general rule states that an individual is an independent contractor if the payer (that’s you, the employer) has the right to control or direct only the result of the work and not what or how the work gets done. Here are three guidelines for making sure your worker is properly classified as an independent contractor:
Independent Contractors or Employees?
Behavioral
Does the company control or have the right to control what the worker does and how the worker does his or her job? That doesn’t mean you can’t discuss what you want done on the project you’re outsourcing or ask for progress updates—but you cannot restrict the hours the person works or where the work should be done. It’s often best to have them perform their tasks away from your place of business.
Financial
Are the business aspects of the worker’s job controlled by the payer? (These include things like how worker is paid, whether expenses are reimbursed, who provides tools/supplies, etc.). Should you pay your independent contractors mileage expenses? What about other expenses? Independent contractors usually pay their own expenses from gross receipts or revenues or bundle the expenses into the overall project cost. However, many businesses do reimburse their independent contractors for mileage and other expenses. Paying expenses does not automatically mean misclassification. The IRS looks at the entirety of the employer/worker relationship. That said, do not offer to pay for materials, such as supplies, mailing tools, etc. that the independent contractors should provide on their own.
Type of Relationship
Are there written contracts or employee-type benefits (i.e. pension plan, insurance, vacation pay, etc.)? Will the relationship continue beyond the scope of the project, and is the work performed a key aspect of the business? Obviously, if you offer benefits, the worker should be classified as an employee. Make it clear the relationship is on a project-by-project basis or is temporary by putting exact wording to that effect in the employer/independent contract along with a specific end date. You can always draw up another agreement if the project is not completed by the stated date.
If you have any doubts about classification, talk to your accountant or file Form SS-8, Determination of Worker Status for Purposes of Federal Employment Taxes and Income Tax Withholding with the IRS. The IRS will analyze assess your situation and make an official decision on the worker’s status. Remember, for every independent contractor who earns more than $600 from your company, you’ll need to issue a 1099 to the IRS, and the contractor will need to fill out a W-9 form.
