One of the challenges of owning a small business is how to manage the numerous tax forms required when paying for services. The one tax form that is used most frequently is the 1099-MISC for payments to independent contractors. This form must be submitted for any payments totaling more than $600 to any one contractor for the year.
While the form itself is not complex, it is important that the business owner submit a form for each provider of services, and to be accurate in reporting the amounts. Also, if an owner is paying for a large amount of services from one contractor, then the IRS may scrutinize the type of work provided to make sure that there is not an employee relationship.
Why Does the IRS Review Independent Contractor Payments?
In essence, by using 1099-MISC to pay for services, an owner is stating the worker is not an employee. Because of this, the owner avoids paying Medicare and Social Security as they would for an employee. The contractor would have to pay those amounts as their own self-employment tax. Also, the owner can avoid providing healthcare or other types of employee benefits, which can amount to a significant savings for a business.
For this reason, the IRS may look at the nature of the work relationship to see if there is an employee type arrangement, which would subject the owner to additional tax burdens. There is a test to determine the status of a worker including these factors:
If there are very specific instructions on how to perform the work, or if the worker is receiving training from the business, then that may indicate employee status. Also, the worker should be in control of their own time and work product to confirm their independent status.
This pertains to the worker’s control over their own business activity and ability to realize a profit or loss that is independent from the business that they serve. In other words, their own financial outcome is not solely related to the work they do for the business, but entails other factors.
The Type of Contract for Services
This may be the determining factor, where actual terms in an agreement for services will detail the amount of control and independence in the relationship. Having a contract for services is helpful if the IRS decided to audit the business.
Tips for Small Businesses That Use Independent Contractors
Given the above factors, there are a few ways for businesses to avoid having contractors assigned employee status.