A common issue faced by business owners is whether an individual should be considered an employee or an independent contractor. As an owner paying for services for the benefit of your business, you may make payments to individuals who are not considered your employees.
A good litmus test and some key factors to determine whether independent contractor status is valid are listed below. But ultimately the question comes back to whether you have the right to direct and control the worker. If the right to direct and control is there, then more than likely you have an employee. The IRS has put forth 20 factor s important to consider in determining employment status. Each of the factors can impact your decision, but the most significant ones are:
· Do you have the right to say where, when and how the worker is to work, and can you require compliance with your instructions?
· Do you pay the worker’s business and travel expenses, or provide the worker with the tools, materials, and equipment to do his job?
If you answered no to the above questions, you may have an independent contractor relationship.
· Do you have the right to discharge the worker without liability?
· Can the worker hire his own employees, or delegate his work as he deems necessary?
If you answered yes to the above questions, you may have an independent contractor relationship.
Another consideration is how you pay the individual. If you pay the individual by the job, again when considered in conjunction with the other relevant factors, this may indicate an independent contractor relationship.
These factors are not an absolute determinate of the relationship, but by considering whether you can direct and control the worker, you should be able to determine whether your position is reasonable.
When an independent contractor relationship does exist, and you pay that person $600 or more during the year, you must provide that person with Form 1099-MISC by January 31 following the end of the year, and send a duplicate copy to the IRS by February 28.
In general, you would not provide benefits to a non-employee, and you would not be required to withhold taxes from your payment for services, or pay an employer portion of Social Security and Medicare taxes. The independent contractor would be responsible for the employee and employer portion of social security and Medicare taxes.
That sounds like a good deal, doesn’t it? Then why wouldn’t you treat all your service providers as non-employees and save the costs of benefits and payroll taxes?
First, there are business considerations. Service providers who are not receiving company benefits will generally not be as loyal to your company; those service providers have the flexibility to provide services to other companies that could use their expertise. Additionally, since you do not have the ability to set their daily schedules, you will lose a degree of control over how and when the services you need can and will be provided.
Second, whether a service provider is an employee is a matter of law, based on the facts and circumstances surrounding the relationship—not simply what you call it. The IRS may challenge your determination and you may end up settling with the IRS or defending your position in tax court. The success of your defense will depend on whether the facts indicate an employee or independent contractor relationship.
Third, unless there is a reasonable basis for treating employees as independent contractors, failing to withhold income and employment taxes from their wages can result in severe penalties and interest, in addition to back taxes (federal, state, Social Security, Medicare) owed. Of course, penalties for intentional worker misclassifications are harsher than they are for inadvertent mistakes.
Your benefit plan may also be in jeopardy if any eligible employees have been misclassified as independent contractors since these employees have been excluded from plan participation. The consequences could be that your retirement plan may lose its tax-favored status.
Still confused? You are not alone. This is admittedly a tricky area, and is often an area that is scrutinized by the IRS upon further examination. If you have trouble making a determination or believe you have made the wrong determination, it may be beneficial for you to have a discussion with your attorney or CPA to see what you can do before the IRS comes knocking.