It pays to be careful when hiring a contractor at your business. Whether or not a worker is classified as an employee or an independent contractor matters greatly for tax and employment law purposes. Also, keep in mind that government agencies regularly audit companies they think might classify employees as independent contractors when they shouldn’t be. Hiring a contractor in place of a regular employee can be the smart thing to do for your business, though, so here are some guidelines to keep in mind.
When deciding whether or not hiring someone as an independent contractor makes sense, it’s helpful to understand how an independent contractor differs from a regular employee. The major difference is the level and type of control the employer has. For an employee, you determine how, when, and where the individual will accomplish a task. Employees are given assignments, space to perform their work, and instructions on how to accomplish their assignment. In essence, you “control” the employee. An independent contractor, on the other hand, is given an assignment; and while you have the right to control the outcome or product, you generally don’t have a say about how he or she goes about completing the assignment.
It’s also helpful to see how the Internal Revenue Service (IRS) determines the business relationship between you and whomever you’ve hired. In determining if someone is an employee or independent contractor, the IRS looks at the following things.
The IRS first looks at factors that demonstrate how much control an employer exerts over a worker to perform specific tasks that he or she has been hired to do. Generally, an independent contractor isn’t given instructions or training on how to perform the work; isn’t evaluated on his or her job performance. The IRS then looks at factors to determine the extent of an employer’s financial control over a worker. Ideally, an independent contractor has his or her own equipment or facilities. Pays his or her own business or travel expenses. Offers his or her services to the public. Is paid by the job or task. Has opportunity for profit or loss (to contrast, there is no opportunity for profit or loss for hourly paid workers). This may be the IRS standard, but remember, different agencies and even courts and states have different rules and different items that they look at. For this reason you should always speak with a contract lawyer when it comes to these things to make sure you do it right. If you are missing an element, you could lose your whole case.
The IRS sees how each side characterizes the other, and how each side sees itself. Typically, an independent contractor isn’t provided with employee benefits, is hired with the expectation that the working relationship will not continue indefinitely. Performs services that are not a part of the employer’s regular business activities. Has signed an Independent Contractor Agreement. This one is key. Make sure there is a written contract.
In preparation for a possible future audit, it can be very helpful to have independent contractors fill out a questionnaire. Design your questionnaire in light of the factors discussed above, and keep in mind that your goal is to elicit answers demonstrating the worker is indeed an independent contractor. In addition to the factors discussed above, try to elicit information such as whether the independent contractor has any professional or business licenses; whether the independent contractor has worked as an independent contractor for other employers in the past; how the independent contractor’s business is structured among other things.
Once you have established an independent contractor status and have the proper documentation, make sure to sign an independent contractor agreement.
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