If you need additional personnel for your business but decideyour business can’t afford to hire any more full-time employees,you might consider using the services of an independent contractor.With an independent contractor, you may save money because youdon’t have to withhold and pay the person’s income, Social Securityand Medicare taxes.
And while independent contractors do translate to lower payrollcosts, be advised that the IRS scrutinizes this whole area verycarefully. The IRS wants to make sure that your workers areproperly classified and paying the government the necessary incomeand payroll taxes that are due.
To stay out of hot water with the IRS, be sure the workers youclassify as independent contractors meet the IRS definition of anindependent contractor. The IRS has a 20-point text its auditorsuse to determine the proper classification. Here’s a list of thesome of the major points:
- Who has control? A worker is an employee ifthe person for whom he works has the right to direct and controlhim concerning when and where to do the work. The employer need notactually exercise control; it is sufficient that he has the rightto do so.
- Right to fire. An employee can be fired byan employer. An independent contractor cannot be fired so long ashe or she produces a result that meets the specifications of thecontract.
- Training. An employee may be trained toperform services in a particular manner. However, independentcontractors ordinarily use their own methods and receive notraining from the employer.
- Set hours of work. Workers for whom you setspecific hours of work are more likely to be employees. Independentcontractors, on the other hand, usually establish their own workhours.
To stay on the right side of the IRS, it’s best to document therelationship you have with any independent contractors in a writtencontract. This can be a simple agreement that spells out the dutiesof the independent contractor. The agreement should state that theindependent contractor, not the employer, is responsible forwithholding any necessary taxes. In addition, have the independentcontractor submit invoices. Also, be sure you file Form 1099-MISC(Miscellaneous Income) at year-end. By law, you’re required to fileand give someone Form 1099 if you pay that person more than $600 ayear. The form must be given to the independent contractor byJanuary 31 of the following year. Form 1099 with its transmittalForm 1096 must be filed with the IRS by February 28 of thefollowing year.
If the IRS finds you’ve misclassified an employee as anindependent contractor, you’ll pay a percentage of income taxesthat should have been withheld on the employee’s wages and beliable for your share of the FICA and unemployment taxes, pluspenalties and interest. Even worse, if the IRS determines yourmisclassification was “willful,” you could owe the IRS the fullamount of income tax that should have been withheld (with anadjustment if the employee has paid or pays part of the tax), thefull amount of both the employer’s and employee’s share of FICAtaxes (possibly with an offset if the employee paid self-employmenttaxes), plus interest and penalties.
