Determining if Your Workers are Employees or Independent Contractors

Determining if Your Workers are Employees or Independent Contractors

Tax law centers around proper classification of a worker as an employee or an independent contractor is often misunderstood exposing the employer/company at great legal and financial risk. The fact that you choose to pay someone as an independent contractor, when you treat them as an employee, will not preclude you from any and all payroll tax issues or those of a general liability nature. A careful review of the tax law, established guidelines, as well as a fair, independent and just review of your own facts and circumstances will more aptly enable you to correctly apply tax rules to the letter of the law and also its spirit. The issue of properly determining a worker's classification centers on several major areas:

Control: Independent Contractors are chose to pick their own work path/procedures.

An employee may be told when, what and how to do the work to be done, whereas an independent contractor is predominately measured on the result and not the process. For example, if you have someone come into your office and perform tasks that you dictate, on your equipment, and basically at your leisure, he or she is most likely an employee.

Conversely, you might retain someone to do the same job but you do not care nor do you unduly influence her coming and goings, the specific steps, or how she performs her contracted job/task. Also if you are more concerned with the end product rather than how the work is completed then she is more apt to be an independent contractor. Often employees by definition and culture are not able to work for others while independent contractors are usually free to work with whomever they chose.
Risk of Loss: Independent Contractors, unlike employees, can lose money on a job.
An employee typically does not have a risk of loss as they usually will work at an employer's office, using the employer's equipment, and normally receive a hourly rate for their services rather than a stated fee for a completed task. An independent contractor however will usually have their own office, a business license, and their own equipment and supplies, which they utilize to perform tasks they contract with others to perform.

Thus they have the ability, by contracting for a fee in return for a completed product, to misjudge the time, energy, and effort required to complete a task and are thereby rewarded, like most business owners, on their ability to make a profit or loss on individual jobs. An employee, in being paid for their time and typically not their end result, however has no such daily exposure to loss.
An employer also typically will reimburse the expenses of an employee and pay for the medical and other fringe benefits whereas an independent contractor usually enjoys no such perks. An employee is typically paid hourly while an independent contractor is often paid a flat fee for a completed assigned task.

Behavioral Issues: Focusing on the end result rather than the process.

Employees usually will have set hours where they are expected to be at work whereas an independent contractor's coming and goings are not regulated but only the timing of when an assigned task or work product is to be completed. An independent contractor's relationship is generally shorter in nature than that of an employee who will often have a continuing relationship with their employer. Although a worker may quit at any time and an employer may terminate the relationship at will, an independent contractor may not be afforded such a luxury as often a independent contractor agreement will call for a contractual task to be completed. Often independent contractors will have a written contract, provide their own workers compensation and liability insurance, as well as decide on which specific tasks and responsibilities they will assume.

The Final Assessment

An unbiased review of these criteria and facts will help the employer make a wise and proper classification of a worker's independent contractor status. There is no one over-riding criterion which will determine a worker's proper status, however a careful review, and scrutiny of the facts will allow for a reasonable and just conclusion. A CPA is often the one who is best served to guide and direct an analytical and careful evaluation of the facts as presented. Also due consideration should be taken to have an attorney to also be involved in drafting an Independent Contractor Agreement so that they might adequately address any intellectual property issues, confidentiality and ownership of all work products.

Frequently you can change the way you are treating a worker to achieve the end result you are seeking. However, due care and diligence should be measured in this circumstance to be sure that you do not achieve one result while dramatically and negatively impacting your entire business operation and its profitability. Having a contract with an independent contractor is important because it specifically and clearly details the responsibilities of both parties. It will not be the determining factor in evaluation of their status as independent or controlled employee. For all employees whom you pay salaried wages or are due same, you will want to ensure that you follow all federal, state, and local taxing authorities so that you are not unduly surprised by additional penalties and interest at a later date.

Filing Requirements

Independent contractors if they are paid over a prescribed limit are required to receive a Form 1099 from their client which details the independent contractor's business name, identifying number, address, and amount earned. This form serves, like a W-2 for employees, to notify the IRS of monies earned and taxable. A payroll service will be your most efficient and prudent resource to handle all of your employee's W-2 filings and payments and Form 1099 issues. Tax law requires you to issue a Form 1099-Misc to all unincorporated independent contractors that you pay over $600 in any given calendar year. This form is to be issued to the independent contractor by January 31st of each year for the prior reporting period.

Determining correct worker status is often a tedious but yet essential and critical process. Whether you are in a crisis mode in the midst of an audit or just getting started ensuring that all of your workers are properly classified and that you maintain proper documentation is essential to sound business management. Stay tuned for our next posting providing an example of a sample independent contractor agreement.

John Dillard is a Christian Speaker/Author and Certified Public Accountant (All Rights Reserved). To See how he takes Christ along with him to work visit http://www.hiscpa.com/ (An Atlanta CPA firm) and for his latest book Overcoming Life's 9/11's: Job's Journey and to learn about his ministry visit http://www.john-dillard.com/