The Accounting Blog

In today’s free market world, more and more companies are hiring people as independent contractors rather than as employees. The big reasons? To save payroll taxes and benefit costs, which together can add an extra 20% to the cost of having an employee. If you’re considering using this strategy, keep in mind that the IRS has criteria for determining independent contractors vs. employees and that penalties can result if you don’t follow the rules. Following are the three criteria that the IRS generally considers to be the most important:

1) Behavior Control. Who decides when, where and how the work is performed? Who decides what tools/equipment to use? If additional staff is needed to help with the job, who hires them? If the worker has control over these decisions, then he/she may be considered an independent contractor. (Example: a case involving carpet installers found that they were independent contractors because they, not the flooring services company, determined the manner and sequence in which jobs were completed. They also used their own tools and hired their own “helper” work force.)

2) Financial Control. Who pays the operating expenses for the work to be performed (i.e. supplies, computer, travel expenses)? Is the worker free to perform services for other companies and/or the public? If the worker controls these decisions, then he/she may be considered an independent contractor. (Example: the carpet installers mentioned above were considered independent contractors because they purchased their own supplies, held the risk of profit or loss on their jobs, and were free to work without penalty for other companies.)

3) Relationship Factor. Who determines the working relationship of the parties? Is the worker provided with employee-type benefits such as insurance, vacation pay or sick pay? Obviously, these types of benefits are only paid to employees, not contractors.

As you can see, the rules are complex and leave some room for interpretation. If you want to increase your chances of convincing the IRS that a worker is in fact an independent contractor, you can take the following steps:

1) Create a simple contract documenting the independent contractor relationship (you can purchase a blank form from Nolo Press). You may wish to specify in the contract that the worker is responsible for his/her own insurance (including workers’ compensation).
2) Pay for work by the job instead of by the hour, the week or the month.
3) Have all workers submit invoices for work before paying them.
4) Don’t forget to complete IRS Form W-9 (Request for Taxpayer Identification Number) when you first start working with a contractor (you’ll need this info. for your year-end tax filings).

(Sources: IRS, American Express Small Business, Quickfinders)

Posted by Will K at 05:54 PM January 28, 2006