Do You Have Independent Contractors?

Are you hiring an independent contractor or an employee? The difference matters - a lot. Be sure you're using the correct classifications for your staff.

Employees and independent contractors may both create and support products or provide services for your customers. They're your company's most valuable assets but the IRS looks at each very differently. And when you hire people and start dealing with their compensation, you, too, need to be very sure that you classify them correctly for income tax purposes.

You probably already know the primary difference between them. An employer pays independent contractors or freelancers a fee for their contributions. With employees, the employer is also responsible for employment taxes and often other benefits.

Characteristics Of An Independent Contractor

Control and Independence

The IRS itself states that "…there is no 'magic' or set number of factors that 'makes' the worker an employee or an independent contractor." And an employer can't use just one factor to make the determination. For example, an employer can't call a worker an independent contractor simply because he or she works out of a home office instead of yours. Rather, the employer needs to look closely at the whole relationship between the company and worker. The employer needs to review the facts. Here is a list of relevant facts.  

Behavioral

Does the employer have the right to control how the worker works? There are four ways to measure here:

• Type of instructions given. Does the employer tell the worker how, when, and where to work? What equipment to use? Where to buy supplies and services? What sequence to follow?
• Degree of instruction. How detailed are the instructions?
• Evaluation system. Is the worker evaluated on how the work is done or just the end result?
• Training. Do you offer initial and periodic training, or is the worker's responsible for his or her own?

Financial

There are several questions to consider here. Does the worker:

• Pay for a significant percentage of the equipment used?
• Have a lot of unreimbursed expenses?
• Have the opportunity to make a profit or loss?
• Feel free to work for other businesses?
• Generally, receive consistent wages for each pay period?

Type of Relationship

How would you and the worker characterize your relationship with each other? Is there a written contract? Employee benefits? Was the worker hired expecting that the relationship would go on indefinitely? Are the workers's contributions to the company a "key activity" of the business?

As you can see, it's more complicated than you might think. The IRS takes this issue very seriously and has been known to follow up with companies where at least some of the classifications were suspected to be in error.

The Form SS-8

One section of the IRS Form SS-8, which can help you with the classification of your workers

When Can You Change A Worker's Classification?

A common question that we receive is whether an employer can change the classification of an employee to an independent contractor.  Whether the reclassification is appropriate depends upon the facts and circumstances.  In order to reclassify an employee to an independent contractor, the employer needs to be able to demonstrate that the services provided by the worker are different from services provided as an employee AND they need to meet the characteristics of an independent contractor discussed above. 

If the change is primarily to avoid employment costs such as benefits and payroll taxes and the employer maintains the same level of control, equipment and supplies, the worker is not an independent contractor.