In our previous article, we reviewed the advantages and disadvantages of hiring independent contractors compared to employees. Small business will want to treat all workers as independent contractors. It is less expensive and less work. Conversely, workers prefer to be treated as employees. The worker will pay less tax and it is less hassle. The small business and the workers have conflicting interest.
Independent Contractor Trap
There are strict IRS rules for properly classifying workers. The rules are based on who has control, the business or the worker.
A local hardware store hires a worker to be a cashier. The owner determines the pay rate, working hours, and how the job is done. The owner has significant control of the worker. The worker should be classified as an employee.
Independent Contractor Example
The same local hardware store is remodeling the break room. The owner hires a worker for the job. The owner and worker enter into a contract. The contract defines the cost, scope of work, and completion date. The owner has limited control on how the work is completed. The worker should be classified as an independent contractor.
It may be simple to properly classify workers when the arrangement is clear. But there are situations when the arrangement is not clear. When it is not clear, the answers to the following questions should be thoroughly reviewed. Answering yes to most of the questions will weigh in favor of employee status. Answering no to most of the questions will weigh in favor of independent contractor status.
Does the business control the working hours, pay rates, pay dates, quality of work, and closely monitor how the work is done? Does the business provide office space? Does the business provide all the major equipment used on the job? Does the worker get paid a flat fee or salary? Does the business limit the working hours? Does the business have the right to fire the worker at any time? Are workers hired on a long term basis? Does the business cover job related expenses? Does the business provide benefits such as health insurance? Do workers believe they are employees? Is the worker not able to operate like business and incur a loss?
It is important to properly classify workers. The business can get in trouble by both the federal and state governments for misclassifying workers.
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IRS Circular 230 Disclosure: To the extent this writing contains advice on a federal tax issue, the advice is not intended to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code, or (ii) promoting, marketing, or recommending to another party any transaction or matter addressed in this communication.