How to Toe the Line When Hiring Independent Contractors and Reap Big Dividends

All you're required to do is inform the IRS if youContractor to hire his or her own assistants and
paid this worker more than $600 in one year.to have as much say as possible in how the work
The phrase Toe the Line is an Americanism firstwill be performed.o Require the Independent
recorded in the early nineteenth century. TheContractor to furnish all or most of the tools,
main meaning of this phrase is 'to conform strictlyequipment and materials needed to complete the
to a rule, command, etc... For example, "Anyonejob.o Avoid a commitment to reimburse the
who doesn't toe the line can expect to meet theIndependent Contractor for his/her business
mayor in court, where, as it turns out, he hasexpenses. If necessary pay the Independent
never lost a suit." (U.S. News & WorldContractor a little more, but have him/her
Report, 1996).assume the responsibility.o If possible, arrange to
And...pay a flat fee for the work rather than an hourly
An Independent Contractor is a person hired toor weekly rate.o Don't provide employee-type
work for others without having the legal status ofbenefits (paid vacation days, health insurance or
an employee.retirement plans).o Make it clear that the
Hiring someone who qualifies as an IndependentIndependent Contractor is free to offer services
Contractor can provide an employer with someto other businesses.o Specifically state in your
very BIG dividends...contract the contractor will carry his/her own
Dividend #1: You don't have to pay theinsurance, including workers' compensation
employers share of the workers Social Securitycoverage.o Keep a file containing the Independent
and Medicare taxes.Contractor's business card, stationary samples,
Dividend #2: You don't have to withhold incomeads, and his/her Employer Identification number to
taxes (federal or state) on his/her earnings.help show the contractor has an established
Dividend #3: Not only do you reduce yourbusiness.o You may need to disclose trade
bookkeeping and financial obligations, you're notsecrets of your business to an Independent
bound by many of the federal and state lawsContractor. If so, include a clause in your contract
that normally govern the employer - employeeprohibiting the Independent Contractor from
relationship.disclosing or making any unauthorized use of
Dividend #4: You don't have to provide office orthese trade secrets.
other work space for the worker.Exceptions to Every Rule
Dividend #5: You don't have to provide fringeAs always, there are exceptions. Certain workers
benefits (vacation, personal or sick time).may fall into special categories and the usual IRS
Dividend #6: You don't have to provide healthcriteria won't apply to them. For example, the
insurance or retirement benefits.federal tax law says the following workers are
Dividend #7: If you become unhappy with theautomatically treated as employees as far as
person's work, you can fire him/her without goingSocial Security taxes, Medicare taxes and federal
through the trauma often associated with firing anunemployment taxes (FUTA) are concerned:o
employee. Plus you don't get stuck payingOfficers of corporations who provide service to
unemployment benefits.the corporationo Food and laundry delivery
All you're required to do is inform the IRS if youdriverso Full-time sales people who sell goods for
paid this worker more than $600 in one year.resaleo Full-time life insurance agents working
You're responsible for filing a Form 1099-MISC atmainly for one companyo At-home workers who
the end of the year if you paid the Independentare supplied with material and given specifications
Contractor $600 or more during the year. Thisfor work to be performed.
form is sent to both the IRS and the contractor.For these workers, you MUST withhold the
There are some basic qualification and guidelinesworker's share of Social Security and Medicare
you'll have to follow when classifying someone astaxes and you MUST pay the employer's portion
an Independent Contractor. As long as you makeof those taxes.
sure you meet these specifications, you won't beBut... there's always a "but", isn't there. (Smile)
challenged by the IRS.You may or may not have to withhold income
A "No Sweat" Classificationtaxes for a legal employee --- this depends on
It must be clear the contractor is in business forwhether the worker qualifies as an employee or
himself. The following characteristics guaranteeIndependent Contractor under the usual IRS
you a "no sweat" Independent Contractorguidelines. For example...
classification.o The worker is available to performFederal law provides that for tax purposes,
services for many businesses.o The worker has alicensed real estate agents and door-to-door sales
fixed base of operation - a commercial or officepeople are generally treated as "non-employees"
location or a room at home and ongoing business--- in other words, they're Independent
expenses.o He or she lists the business in theContractors. But... people in these positions may
phone book or through newspaper ads, radiobe treated as employees for the purpose of
commercials, circulars, or other advertising media.ostate payroll taxes and workers' compensation
He or she undertakes a job based on the resultscoverage.
the client wants, but remains free to decide howOr...
to get the job done.o The worker hires and paysAs a sole proprietor or partner in your own
for assistants, as needed.o He/she has investedbusiness, you're neither an employee nor an
significant money in the business for equipment,Independent Contractor. You're responsible for
vehicles and supplies.o Depending on how hispaying your own income tax and Social Security
business goes, the worker may earn large profits,self-employment tax. But, if you're a shareholder
small profits or none at all --- perhaps evenin a corporation and provide services to that
suffers a loss.o He/she incurs expenses in doing acorporation, you're considered an employee.
job that won't be reimbursed by the client.The IRS analysis of who qualifies as an
Be very careful you don't cross the line betweenIndependent Contractor is similar to the standards
Independent Contractor and Employeefollowed in most states for state taxes and
If the work arrangement shares someunemployment rules... BUT...
characteristics of an employment relationship andIn California, a person working for a licensed
some characteristics of the Independentcontractor who performs services requiring a
Contractor, you are at risk with the IRS. Tolicense (i.e. erecting a building) is considered to be
ensure you don't invite an IRS audit there arean employee unless the worker also has a valid
two safe solutions to avoid crossing thiscontractor's license.
somewhat ambiguous line.So, Cover Your A--! If you plan to hire
Treat the worker as an employee. If you wantIndependent Contractors, check with the
to be safe and avoid any risk the IRS or anyemployment office in your state to see if special
other government agency might determinerules apply.
you've mistakenly classified a worker as anMistakes of Miscalculation
Independent Contractor, follow the policy ofThere are at least three ways the IRS can learn
always treating the worker as an employee.about your hiring and classification practices.
Just remember, by doing this you and the workerFirst, the IRS may look into the affairs of an
will lose the advantages of the IndependentIndependent Contractor who hasn't been paying
Contractor relationship.his/her income taxes.
Require the worker to incorporate. The IRS willSecond, disgruntled employees may complain to
almost always treat this as a valid arrangementthe IRS if they believe an Independent Contractor
and accept the fact that the worker isn't youris getting favored treatment.
employee but an employee of his or her ownThird, during tax audits, the IRS routinely check to
corporation. It's legal in every state to formsee if workers have been misclassified as
one-person corporations and the process can beIndependent Contractors.
simple and relatively inexpensive to do.The presumption is always the worker's an
Here's how it would work...employee unless proven otherwise. If the status
First, the worker forms a corporation under stateof a worker is questioned, it's up to you to prove
law and obtains an Employer Identification numberthe worker's an Independent Contractor rather
from the IRS.than an employee.
Second, you sign a contract with the corporation.If it's proven that a worker was misclassified, it
The corporation agrees to provide specifiedwill cost you... BIG time. You'll be responsible for
services for your business.paying the employee's Social Security tax, federal
Third, the corporation hires the worker (whoincome tax and federal unemployment insurance
owns the corporate shares) as an employee tofor up to three years... plus penalties and interest.
perform services required by your contract withState government officials are also interested in
the corporation.businesses that misclassify employees as
Fourth, the corporation bills you as services areIndependent Contractors. A state employment
performed for your business under the contract.office may audit your business to see if there's
Fifth, you pay the corporation...not thebeen any misclassification. The audit can be the
employee...for the services billed to your business.result of a spot check by the state employment
Sixth, each time the corporation issues aoffice or a request by an Independent Contractor
paycheck to its employee, the corporationfor unemployment or worker's compensation
withholds federal income taxes, along with thebenefits. You may wind up owing money to a
employee's share of Social Security and Medicarestate unemployment insurance fund...
taxes. Periodically the corporation (using its ownAnd...
Employer Identification number) pays the IRS theIf the IRS gets wind of the state's action, you'll
withheld taxes along with the employer's share ofprobably face a federal audit too.
Social Security and Medicare taxes.Again, it would be wise to get the advice of a tax
Accept a Measure of Risk.expert before classifying someone as an
If treating the worker as an employee orIndependent Contractor. Running your business as
requiring the worker to incorporate aren'ta corporation or an LLC may not protect you
practical, then you need to understand you'refrom personal liability for these penalties. If you're
opening yourself up to some legal risk. One wayan officer of the business or have authority to
to reduce this risk is to get professional advice.make payroll decisions, you may have to pay the
See a tax expert, a lawyer or an accountantpenalties yourself.... OUCH!
familiar with worker classification issues.So...
Another way you can reduce risk is to follow asWhile there are definite benefits to hiring
many of the following suggestions as possible...oIndependent Contractors, you must take
Sign a contract with the Independent Contractormeasures to protect yourself and your business
spelling out the responsibilities of each party andfrom simple miscalculations.
how payment is to be determined for each job.Just remember to always toe the line when
The contract should allow the Independentdealing with the nebulous "buts" of the law.