Many small businesses rely on independent contractors for a lot. For some businesses, they are integral to day to day operations. For others, independent contractors are for special projects and services. And with the rise of the gig economy, you’ll probably find yourself using contractors even more often.
You can face major penalties if you mix up independent contractors and employees. However, it is important for tax reasons to keep them separate. The IRS uses about 20 factors t0 determine if someone is a contractor or employee.
However, there’s really five core issues that the IRS will look at.
5 Keys to Independent Contracting
The common thread through these keys is control: the IRS considers companies that have a lot of control over their workers to be dealing with employees. Less control, and you can classify workers as independent contractors.
How is the work done?
First, they’ll look at how the work is actually done. If the independent contractor does work from their own place or office, sets their own hours, works when they want, and uses their own tools—that’s in your favor. If the contractor is working in your own building, on your hours, with your tools, you probably have an employee on their hands.
Of all the 20 metrics that the IRS can use to determine employment eligibility, this is basically the eye test. If you can pass this one, then you probably can contract.
Does the contractor need training?
Contractors generally bring a set of skills to your business. You can get an independent contractor to design your office, build your website, promote your company
Is the contractor working on specific projects?
Contractors generally sign contracts to work on a particular scope of work. They don’t generally log 40 hours a week of random projects that you throw them. There are exceptions of course, but specific contracts that are signed for specific projects generally make someone an independent contractor.
Is the contractor paid often?
Employees are generally paid twice a week at an hourly rate. Contractors are generally paid a flat rate per project, or if they are paid hourly, then it is according to the number of hours it would take to complete the project.
Employees receive payments for expenses like travel and business supplies. Contractors may have these costs factored in, but they receive a fixed rate for the total project or the hours work. Contractors don’t usually recoup travel costs except through charging over the top of their costs.
Other Considerations: Critical Functions
Another phrase you’ll hear is “critical” or “key” to business functions. If the work of the contractor is critical to the basic functioning of the business, then they might be an employee.
Costs of Misclassifying a Worker
Again, failing to meet one of the 20 standards that the IRS uses won’t mean that you’re open to legal repercussions. No independent contractor meets all 20 tests. But the penalties for getting it wrong can be really bad.
If a worker is misclassified in an unintentional way, there are taxes, fines, and penalties that have to be paid on top of the charge. But in more extreme examples, a business could get entangled in criminal lawsuits and might have to pay overtime for their workers. Additionally, you might get sued for the work that a contractor did—and you could potentially lose ownership of the work.
Employment Law Assistance
If you have your doubts about employment law, a lawyer can look over the structure of your company to help you determine whether or not you should be able to classify your personnel as independent contractors or employees.