Treating New Hires as Independent Contractors (The Tax Guy)

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Treating New Hires as Independent Contractors (The Tax Guy)

Posted by baracc 317 days ago (http://www.smartmoney.com)

Cost savings are on top of any business owner’s mind these days. And even if the business is doing so well that you need to expand your staff, you may be terrified of all the obligations that go along with hiring a full-time employee. I don’t blame you.
One solution: Hire an independent contractor.
Unfortunately, the government hates the idea of independent contractors and the IRS has been skirmishing with taxpayers for decades about the so-called worker classification issue. Here’s what you need to know to avoid problems.
Why worker classification matters
When a worker is classified as a “common law employee,” your business generally must withhold federal income tax (FIT) and the employee’s half of Social Security and Medicare taxes from the worker’s wages. Your business must also pay the employer’s half of Social Security and Medicare taxes, pay federal unemployment tax (FUTA), file federal payroll tax returns, and follow tons of burdensome IRS and Department of Labor (DOL) rules. You may also get socked with state and local unemployment and worker compensation taxes and have to comply with even more rules and regulations. Dealing with all this stuff can cost thousands and thousands of extra dollars per year for each employee. Not good.
To determine who is considered a common law employee, various statutes, regulations and court decisions come into play -- and IRS and DOL rules can differ from state and local rules. That said, if you’re allowed to treat a worker as an independent contractor under IRS rules, you’ll generally be in good shape across the board. So I’ll mainly talk about IRS rules here.
With an independent contractor, you don’t have to worry about employment tax issues and you don’t have to provide expensive fringe benefits like medical insurance (a hot-button issue these days), retirement plans, paid vacations and so on. If you pay $600 or more to an independent contractor during the year, you must issue a Form 1099-MISC to report what you paid. That’s generally about the extent of your bureaucratic responsibilities.
Here’s the rub: If you treat a person who is actually a common law employee as an independent contractor, your company could be assessed big bucks for unpaid taxes plus interest and penalties. You could also be on the hook for employee benefits that should have been provided but were not. The cost of being on the wrong side of a worker classification controversy has driven businesses straight into bankruptcy.
How to lock in independent contractor status
Despite lots of rhetoric on the subject, it all boils down to this: A worker is an independent contractor if you have little to no control over the way that person gets the job done. If you insist on lots of day-to-day supervision, the worker is probably a common law employee.
So if you just tell the worker what you want accomplished and by when and then stand back, you have an independent contractor relationship, right? Well, it’s not quite that simple. The worker could still be a common law employee if he or she works full time for you, has no other significant clients, is required to make extensive daily progress reports, and gets paid by the hour (or day or week or month) rather than by the job.
Although it certainly helps your independent contractor argument if the work is performed away from your premises, that fact alone is not a cure-all.
Finally, if you are treating or have treated another worker in essentially the same circumstances as an employee, you’ve shot yourself in the foot. Don’t do that.
Here’s some specific advice: Use a written contract for any worker you want classified as an independent contractor. Taking this step will help resolve ambiguous situations in your favor. The contract should refer to the worker as a contractor and refer to payments as contract payments (not wages). It should not prevent the worker from taking on other projects, and it should not require full-time work for you or working every day on your premises. Payment should be due on completion of the project or at designated progress points. The contract term should be limited rather than open-ended, and it should say you won’t pay for expenses except in specified instances (like when travel is necessary). Of course, you must live up to the contract for it to do any good.
Covering all your bases
If you follow my guidelines, you should be good. However, it never hurts to hear the other side of the story. Go to the IRS web site and print out Form SS-8. You can turn in this form if you want the IRS to tell you how to classify a worker, but you may not like the answer. While on the IRS site, plug worker classification into the search engine. Read what you find while sprinkling it liberally with salt and keeping what I said in mind, since I’m on your side.
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