Independent Contractor vs. Employee, and How to Tell – Part 2

Independent Contractor vs. Employee, and How to Tell – Part 2

In my last post I covered the basic IRS rule of independent contractor vs. employee classification. In this emergent Freelance Economy, this question is becoming more and more relevant every day. Here are the detailed questions to to help you determine whether you've got your contract workers correctly classified.Are the business aspects of the worker’s job controlled by the payer?
These include things like how the worker is paid, whether expenses are reimbursed, who provides tools/supplies, etc. In typical government style, this test also has several key parts:Does the contractor have a significant investment in the tools and equipment needed to do the job or is the employer providing these items? The greater the investment by the contractor the greater the likelihood he can be considered a contractor.Are expenses reimbursed by the employer? The greater the expense reimbursement, the less the likelihood that the worker is a contractor.Other factors defined by the IRS include:Is pay hourly, or priced as a whole job? Contractors typically do not work by the hour but by the job. Hourly pay looks more like an employee, and can be one factor the IRS considers. However, most professionals working through Spare Hire are working in finance and other areas where it is typical for consultants to charge by the hour, so this factor is less important to our clients.Are there written contracts or employee-type benefits (i.e. pension plan, insurance, vacation pay, etc.)? While again not a hard and fast rule, generally contractors don’t receive benefits.Will the relationship continue and is the work performed a key aspect of the business? For this test the IRS uses some scary language – “This type of relationship refers to facts that show how the worker and business perceive their relationship to each other.” Wow, clear guidance there. However, just like in the first two tests the IRS spells out some things to consider:Is the relationship between the employer and the worker short term or permanent? Job-based or long running? Generally, the longer the duration of the relationship, the greater the chance that the IRS will look at the worker as an employee.Although there may be a contract which says the worker is a contractor, that doesn’t necessarily make it so. The IRS looks at the rules above to determine whether the actual behavior of the worker and the employer says contractor or employer.As an employer, what does it all matter? One word: Money. The IRS estimates that it loses billions of tax dollars each year as the result of improperly classified employees, and they aren’t happy about it. That’s why IRS investigations of employee classification are on the increase, and why being caught with misclassified employees can cost a company big. If your company uses independent contractors – and more and more workers are working this way - be sure to carefully follow the rules and to make the decision of independent contractor vs. employee based on these rules, and not on the desire to save a few tax or admin expenses.

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