Are you classifying the people performing services for your business as independent
for IRS tax purposes? Is it possible that they might really be employees for
workers are classified for IRS tax purposes has major tax consequences because employees and independent
contractors are treated differently for IRS tax purposes. Potential disasters await your
business if the worker is classified for tax purposes improperly. Improper classification
for tax purposes can cause
problems that could financially destroy your business. Business owners must withhold
income tax on employees' wages, and must pay Social Security tax (FICA) as well as
withhold the employees' portion of the FICA. They also are responsible for unemployment
tax (FUTA) and must provide the employee with a Form W-2, "Wage and Tax
Statement," showing the amount of wages and tax withheld for the year.
Payments to an independent contractor that total $600 or more for the
must be reported by the business owner on Form 1099-MISC, "Miscellaneous
Income," and filed with the IRS. A copy also must be given to the independent
The key factor which determines whether a worker is an independent
contractor is who has the right to control the worker as to how work is accomplished?
Government entities, interested or damaged third parties, and perhaps the
worker himself will often later challenge the classification as independent contractor for
a variety of reasons. Enormous tax problems can result from improper
classification for IRS tax purposes.
The IRS has developed twenty common law factors which are used on a case
by case basis to determine whether a worker is an independent contractor or an
employee for IRS tax purposes.
Independent contractors do not have to satisfy all of the twenty common law factors. It is
best to think of the factors as weights on a balance scale.
The twenty common law factors of a perfect independent contractor
Independent contractors are not required to follow, nor
are they furnished with, instructions to accomplish a job.
No Training. Independent
contractors typically do not receive training by
the hiring firm. They use their own methods to accomplish the work.
Others can be hired. Independent
contractors are hired to provide a result
and usually have the right to hire others to do the actual work.
contractor's work not essential. A company's success or
continuation should not depend on the service of outside independent contractors. An example violating
this would be a law firm which called their lawyers independent contractors.
No time clock. Independent
contractors set their own work hours.
No permanent relationship. Usually
independent contractors don't have a
continuing relationship with a hiring company. The relationship can be frequent, but it
must be at irregular intervals, on call, or whenever work is available.
contractors control their own workers. Independent
hire, supervise, or pay assistants at the direction of the hiring company. If assistants
are hired, it should be at the independent contractor's sole discretion.
Other jobs. Independent
contractors should have enough time available to
pursue other gainful work.
contractors control where they work. If they work on
the premises of the hiring company, it is not under that company's direction or
Order of work. Independent
contractors determine the order and sequence in
which they will perform their work.
No interim reports. Independent
contractors are hired for the final result
only. They should not be asked for progress or interim reports.
No hourly pay. Independent
contractors are paid by the job, not by time.
Payment by the job can include periodic payments based on a percentage of job completed.
Payment can be based on the number of hours needed to do the job times a fixed hourly
rate. Payment method should be determined before the job commences.
Multiple Firms. Independent
contractors often work for more than one firm
at a time.
Business expenses. Independent
contractors are generally responsible for
their own business expenses.
Own tools. Independent
contractors usually furnish their own tools. Some
hiring firms have leased equipment to their independent contractors so that they could
show the independent contractor had their own tools and an investment in their business. This strategy
won't work if the lease is for a nominal amount or can be voided by the hiring firm at
will. The lease must be equivalent to what an independent business person could have
obtained in the open market.
Significant investment. Independent
contractors should be able to perform
their services without the hiring company's facilities (equipment, office furniture,
machinery, etc.). The independent contractor's investment in his trade must be real, essential, and
Services available to the public. Independent
contractors make their
services available to the general public by one or more of the following:
1) having an office and assistants;
2) having business signs;
3) having a business license;
4) listing their services in a business directory; or
5) advertising their services.
Profit or Loss possibilities. Independent
contractors should be able to
make a profit or a loss. Employees can't suffer a loss. Five circumstances show that a
profit or loss is possible:
1) the independent contractor hires, directs, and pays assistants;
2) the independent contractor has his own office, equipment, materials, or facilities;
3) the independent contractor has continuing and recurring liabilities;
4) the independent contractor has agreed to perform specific jobs for prices agreed upon in advance;
5) the independent contractor's services affect his own business reputation.
Can't be fired. Independent
contractors can't be fired so long as they
produce a result which meets the contract specifications.
No compensation if the job isn't done. Independent
responsible for the satisfactory completion of a job or they may be legally obligated to
compensate the hiring firm for failure to complete.
If a worker clearly is an independent contractor, a complete agreement to
that effect is useful and recommended; however, any agreement, no matter how well drafted
and explained to each party and signed, will not change the results if a person is held to
be an employee under the facts and circumstances.
The laws surrounding the employee versus independent contractor issues are
extremely complex and you should consult with a tax attorney on these issues.
Improperly classified employees can cause business owners to end up with
hefty tax penalties for nonpayment of employment tax. Those who need help deciding if their
workers are employees or independent contractors can fill out Form SS-8, Determination of
Employee Work Status for Purposes of Federal Employment Tax and Income Tax Withholding.
The IRS will tell them if their workers are employees or independent