Independent Contractors. . .
There are an estimated seven to eight million independent contractors in the United States. (1) People like working for themselves--and businesses like using their services, because it saves them state and federal taxes and insurance premiums and lots of paperwork. But who is an independent contractor, and who is just a worker? The answer is as messy as a snake pit, and at least as dangerous. If the IRS decides that some of your independent contractors are really employees, you'll have to pay all the back taxes due on their wages, PLUS a possible penalty that ranges from 12% to 35% of the tax bill. (2)
Still, independent contractors can be a real savings to small businesses. Taxes, workmen's comp, unemployment insurance, and other employee costs add at least 20% to 30% to a worker's salary or hourly wage. (3) Smaller firms regularly contract out everything from office cleaning and food services to payroll preparation and accounting. So what can you do to maximize your chances of accurately classifying someone as an independent contractor (IC)?
Remember that word "independent." The main consideration is how much control you exercise over the workers. Can they perform the job on their own schedule? Can they work for other businesses at the same time? Do they use their own equipment? Do they get training at their own expense? A few years ago, the IRS established a 20-factor test, which can be seen presented in chart form at " Employee or Independent Contractor." The IRS no longer relies exclusively on this test, but it's still a good guideline. (4)
Several things--while not absolutely required--seem mandatory in actual practice. First is a paper trail: a written agreement, and IRS Form W-9 (Request for Taxpayer Information) for all ICs. This will give you their social security number or federal I.D. number and mailing address. You'll need this information at the year's end to make out their 1099--currently required if you paid non-incorporated ICs at least $600. (5) Also require an invoice from all ICs before issuing checks, even though you both know how much is owed. The paper trail reinforces the IC image.
Second, ICs should perform some unique service for your business. If you already have a bookkeeper employee, additional bookkeeping help will probably be classified as employees--no matter what you call them. Don't mix employees and ICs on the same task. (6)
Third, the task ICs perform should be outside your primary line of business. For example, many small firms contract out their cleaning work. But if you ARE a maid service or commercial cleaning firm, your workers are probably employees, not ICs. One self-help publisher offers a chapter from its book on ICs online. It gives more examples of who is and who isn't an independent contractor. The book itself contains a sample IC agreement. Another agreement form can obtained through subscription to the online publication The Independent Contractor Report
The law favors employee status. Health and safety regulations, deemed necessary for the public good, apply to employees but not to independent contractors. State and federal taxing authorities, the IRS among them, prefer the guaranteed withholding and payment of payroll taxes required of employers, versus independent contractors who are responsible for their own taxes. (7)
Businesses can often save time, money and paperwork by hiring independent contractors instead of employees. Approximately 60% of all American businesses use ICs. (8) Stay informed. Check out the California Society of CPAs' advice for a summary of current law. Consult your own lawyer and tax accountant. Then cash in on the savings.
By Paula Damiano
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NOTE: See also IRS publications 15A, Employer's Supplemental Tax Guide; 1. Who Are Employees? and 15A, Employer's Supplemental Tax Guide; 2. Employee or Independent Contractor? You can order forms and publications through their website at www.irs.ustreas.gov/.
Reference sources:
(1) Business Savvy. Advertisement for "Wage Slave No More: The Independent Contractor's Legal Guide" by Stephen Fishman. http://www.businesssavvy.com/100738n.html.
(2) "Independent Contractors vs. Employees." http://www.intuit.com/turbotax/taxenter/busguide/indcontp.html.
(3) "FAQ for Firms Hiring Independent Contractors." http://www.nolo.com/ChunkSB/faqhire.html.
(4) "IRS Guidelines/Know the difference: employee or contractor." Printing Industries of America, Inc. http://www.printing.org/HumanRelations/Advisories/0197.htm.
(5) "The Puzzle Of Who Is A 'Contractor'." Business Week Frontier. 9.1.97. http://www.businessweek.com/smallbiz/news/columns/97-35/e3542024.htm.
(6) Ibid.
(7) "Independent Contractors." http://www.smallbiz.findlaw.com/text/P05_0085.stm.
(8) "IRS Issues Draft Training Guide On Employee/Independent Contractor Status." Seyfarth Shaw Fairweather & Geraldson website. Reprinted from Labor & Employment Law Report, May 1996. http:www.seyfarth.com/practice/labor/articles/II_1164.html.
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