Initially, it’s up to you to classify and pay a worker properly as either a contractor or employee. Using contractors, of course, involves far less paperwork and doesn’t require you provide benefits, insurance or do tax withholding, among many other things. But you can’t have it both ways: Under U.S. law, a worker is either a contractor or an employee. Period.
And be aware that the IRS does actively pursue businesses that intentionally misclassify workers. Most misclassifications are not intentional, however, and government agencies are willing to work with businesses that attempt to comply with the rules.
The biggest single consideration that determines the difference is control. According to the National Federation of Independent Business (NFIB), employees are generally subject to employer control, while independent contractors retain considerable control over the services they provide to the businesses that hire them.
The NFIB, which is the largest small business advocacy organization in the U.S., defines the two categories of workers like this:
“A person hired for a regular, continuous period to perform work for an employer who maintains control over both the service details and the final product.”
“A worker who performs services for others, usually under contract, while at the same time retaining economic independence and complete control over both the method by which the work is done and the final product.”
According to the NFIB Small Business Legal Center, your main focus when deciding whether to classify a worker as an employee or independent contractor is the issue of control. NFIB offers this advice on how to use independent contractors without running into trouble:
- Require the Independent Contractor to Incorporate: By incorporating, the worker will be considered an employee of his or her own corporation, and not the employee of the business that hired the worker. The independent contractor’s corporation should bill the business and the business in turn should pay the corporation, not the worker personally. Almost anyone can set up a corporation online, easily and inexpensively.
- Sign a Contract: A clear agreement with the worker that the employment status will be that of an independent contractor should also outline the jobs and positions of both parties, indicating form of payment (preferably a flat fee, rather than an hourly wage) and, if possible, stating that the worker will carry his or her own insurance.
- Clear Communication: Explain to the independent contractor that he or she is free to provide services to others, not just to your business.
- Keep Finances Separate: Require that the independent contractor keep his or her own accounts on materials and equipment needed to perform the services.
- Treat Independent Contractors Differently From Employees: Do not provide employee benefits to the independent contractor, such as paid vacation days or insurance.
- Treat All Independent Contractors Alike: In the event of an audit, equal treatment of similarly situated workers shows that the decision to classify a worker as an independent contractor is a substantial one.
The NFIB offers an excellent and highly comprehensive guide to using independent contractors that you can download at their website here: www.NFIB.com/icguide. It carries at $12.95 cover price, but the download is actually free.
It includes a list of the 20 factors – also called the Common Law Test – that government agencies use to determine whether a worker is an employee or contractor. These include such things as how much instruction you provide, who sets the hours and work sequence, who pays expenses, and many other things.
The guide also includes a helpful set of examples from businesses such as a roofing company, freelance photographer, cleaning service, restaurant and flower shop. And there’s also a sample Independent Contractor Agreement that you can adapt to your own business.
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