Contractor or Employee? The IRS will decide.

Pay TaxesMore and more businesses are meeting their needs by hiring independent contractors.  Business owners benefit by avoiding the administrative hassles and the out-of pocket costs of payroll taxes and fringe benefits. The trend toward independent contractors will likely continue as business owners cope with the insurance mandate of President Obama’s Patient Protection and Affordable Care Act by hiring independent contractors rather than full-time workers.

There is a fine line between an independent contractor and an employee. Here are some of the factors that are considered:

Behavioral Control Factors: These factors measure whether there is a right to direct or control how the work is done.

  1. Are there little instructions given to the contractor about how, when, and where the work is done?
  2. Is little training is provided by the company?
  3. Is the contractor required to perform the services personally?
  4. Does the contractor hire, supervise, and pay his or her own assistants?
  5. Is the relationship with the company continuing or is infrequent?
  6. Does the contractor set his or her working hours?
  7. Does the contractor work full-time for the company?
  8. Does the contractor does work at the company’s location?
  9. Does the contractor sets the steps in which the work will be done?
  10. Is the contractor is not required to submit written or oral reports?

Financial Control Factors: These factors measure whether there is a right to direct or control how the business aspects of the worker’s activities are conducted.

  1. Is the contractor paid by the job rather than by the week or month?
  2. Is the contractor reimbursed for business or traveling expenses?
  3. Does the contractor provide his or her own equipment and supplies?
  4. Does the contractor invest in the facilities used for doing the work?
  5. Does the contractor can realize a profit or suffer a loss as a result of providing the services?
  6. Does the contractor work for different companies at the same time?
  7. Are the contractor’s services available to the general public on a regular basis?

Relationship Factors: These factors measure how the parties perceive their relationship.

  1. Can the contractor be fired as long as he or she produces the requested work?
  2. Can the contractor terminate the relationship with the company before the work is complete?

The application of these factors is illustrated by a recent case.  In Atlantic Coast Masonry, Inc. The workers provided their own tools and were free to seek employment with other businesses, the construction company always delivered instructions to the workers prior to commencement of the project and many workers worked exclusively for the construction company. The workers worked a required eight-hour day; they could be fired at will; and they received weekly cash payments based on their productivity. In other words, how the business owners and contractors characterize the relationship does not necessarily control. The IRS reclassified masons as employees and charged the construction company $700,000 in back taxes.

There are 3 important steps business owners can follow to make sure the independent contractor relationship is honored.

  • First, define the relationship in a written business document.
  • Second, structure the work relationship in such a way, using the 19 factors as a guide, that it is an independent contractor relationship.
  • Third, comply with the IRS’s reporting requirements, primarily the issuance of Form 1099s for the independent contractors.