Many businesses use independent contractors as a way to keep payroll taxes to a minimum and reduce the cost of fringe benefits. But using outside workers may result in other problems. It’s common for the IRS to question businesses about whether workers should be classified as employees or independent contractors for federal employment tax purposes.
If the IRS reclassifies a worker as an employee, your company could be hit with back taxes, interest and penalties. You could also be liable for employee benefits that should have been provided but weren’t. In addition to state audits, audits by state agencies may also occur.
The key is control
How can you safeguard your use of independent contractors? Unfortunately, there is no single factor to determine a worker’s legal status. The issue is complicated, but the degree of control you have over how a worker gets the job done is often considered the most important factor. Little or no control indicates independent contractor status.
The IRS looks at a number of other issues, including:
Tools and facilities: Employers usually give tools, equipment and workspace to employees, while contractors invest their own money in these items.
Hours: Employees generally have set schedules, while contractors are allowed greater flexibility. (However, the IRS recognizes that some work must be done at specific times.)
With those guidelines in mind, here are some tips:
- Clarify the relationship with a written independent contractor agreement. Include details, such as the services the contractor will perform, the term of the agreement and how much you’ll pay. Include statements that the individual is an independent contractor and will pay federal and state taxes.
- Give contractors leeway over how they perform their duties. Resist the urge to supervise them the way you oversee employees.
- Send each contractor (and the IRS) a Form 1099 showing non-employee income if you pay him or her $600 or more in a calendar year.
- Maintain good records. Keep an independent contractor’s taxpayer ID number and other information required by the IRS, but also keep items that can help prove the person is self-employed. For example, retain business cards, letterheads, invoices and advertisements from independent contractors.
In many cases, proactive planning can help secure independent contractor status. Contact us if you have questions about worker classification.