Don’t Make This Common Small Business Mistake:
Know Independent Contractor Requirements or Pay Big!
We often speak to small business owners who use “independent contractors” to perform services their business’s need. The attraction is clear… using independent contractors can save businesses money on payroll taxes, worker’s compensation insurance, and fringe benefits. In addition, it allows more flexibility for businesses who don’t have a regular need for certain types of skills, such as certain specialized skills or for seasonal businesses. When used and classified properly, engaging an independent contractor versus hiring an employee can save a small business money.
Benefits aside, every time we hear a business owner uses what they deem “independent contractors”, our attention is piqued. We have seen many small business owners classify certain people they pay as “independent” only to find out later that they were mistaken in that classification. In fact, according to the IRS, if you purposely misclassify employees as independent contractors, you can face fines of $1,000 to $15,000 per instance or even a criminal prosecution.
Independent Contractor or Employee: How do you know the difference?
There are no hard and fast rules for determining who is a contractor versus who is an employee. Or to use words directly from the IRS website:
There is no “magic” or set number of factors that “makes” the worker an employee or an independent contractor, and no one factor stands alone in making this determination.
There are three general guidelines for figuring out how one should classify a worker:
- Control – How much control does the person have over how that do their job? Can the person chose when to work? Does the person have to wear a uniform or have to maintain certain appearance standards? If the person has a great deal of discretion over how they perform their work, the person is more likely to be considered an independent contractor.
- Financial Arrangement – Is the “profitability” of the job determined by the worker? Does the worker have to pay for materials, expenses, tools, extra help / hours out of their pocket? If there is no financial variability in the “profitability” of the job for the worker, he or she is more likely to be considered an employee.
- Business Relationship – Does the worker have a contract with the company? Does the worker receive benefits? An independent contractor will tend to have a contract, while an employee will tend to receive benefits.
If you hire and pay the contractor through a Freelancer site like Freelancer.com, Elance.com or Odesk you can almost always classify the person as an independent contractor.
Check out this link for the IRS guidleines: http://www.irs.gov/Businesses/Small-Businesses-&-Self-Employed/Independent-Contractor-Self-Employed-or-Employee
Don’t forget about the paperwork!
For independent contractors that are US residents or US citizens, you will need to have to the contractor fill out a W-9 Form. If you pay an unincorporated contractor (these include partnerships, sole proprietorships, disregarded entities, and LLCs taxed as such) more than $600 per year, you’re required to issue the independent contractor a 1099-MISC by January 31st of the calendar year following when the contractor received payments. Additionally, you must submit to the IRS a copy of a 1099-MISC by February 28th (mail) / March 31st (electronic filing).
For contractors outside of United States, you should establish the contractor’s foreign residency. This can be accomplished by having the contractor fill-out a W-8BEN form. Click here for instructions.
So What Does It All Mean?
Hiring independent contractors is a good thing in certain situations and can save you money…but use them appropriately to avoid paying more in the long run with penalties and fines. If you need help determining how to classify a worker or filling out the appropriate forms, please contact Barba CFO. We can provide you the small business accounting help you need.
We provide small businesses with accounting help and CFO for hire services in Rhode Island, Massachusetts and Connecticut.