Using an independent contractor, rather than a traditional employee, can provide many tax advantages. For example, classifying a worker as an independent contractor removes the requirements of overtime pay, unemployment compensation, and other employee benefits. Independent contractors also free a business from payroll tax liability, as well as the task of withholding income taxes and the worker’s share of payroll taxes.
The significant advantages of using an independent contractor create strict IRS guidelines for classification. Misclassifying what the IRS considers a regular employee as an independent contractor can hit your business with back taxes, interest, and penalties.
What is an Independent Contractor?
Generally, independent contractors are classified by the IRS by whether a business has the following:
A short-term relationship with the contractor.
Independent contractors are to be hired for a discrete project, whereas employees are to be hired indefinitely. If a worker serves a key business function, they are very likely to be classified as employees.
Little behavioral control over the contractor’s services.
The greater control the company has over the tasks a worker completes, the more likely they are to be an employee rather than an independent contractor. One key factor is the amount of training and evaluation of a worker’s performance the company has. Another consideration is the extent to which a company oversees work. This might include instruction on where and when to do work, what tools and equipment to use, whom to hire, where to purchase materials and so on.
A low level of financial control over the contractor.
An independent contractor will usually be paid a flat fee for their services, while an employee is paid by the hour, week, or other time increment. Independent contractors will usually provide their own equipment or facilities, incur unreimbursed business expenses, and market their services to other customers.
Classifying your workers
It is important to take the entire relationship with a worker into account when reviewing whether they are an employee or an independent contractor. There are several strategies to ensure your workers are classified correctly.
First, err on the side of caution. If you are unsure how to classify a worker, you should probably make them an employee. This may lose some tax benefits, but it will eliminate the risk of an IRS reclassification.
Second, ensure all relationships with independent contractors are in compliance with IRS requirements. For example, you may need to reduce your behavioral control by allowing workers to set their own hours or work from home.
It is worth considering using an outside employee-leasing company. Workers that are leased from these firms are employees of the leasing company, which takes the responsibility for taxes, benefits, and other employer obligations out of your hands.
Misclassifying a worker can carry with it many negative consequences. Taxes, interest, and penalties are some of the most obvious but not the only consequences in play. Your business could also be liable for employee benefits that should have been provided previously but were not. Careful classification can ensure that independent contractor status for your workers is approved by the IRS. If you have any questions about independent contractor classification, we can help. Contact us at 949-860-9902 or click here, and we will contact you.