Independent Contractor or Employee?

By Laura Duggan     Add your comments

Leveraging contractor services can help your cash flow as your start your company, if you know the rules.

Benefits of Contractor Services

It’s often tempting when starting or growing your business to use contractors rather than employees. You don’t have to pay benefits, payroll taxes, and can terminate at will much more easily. You may pay more on an hourly basis, but it is more than accounted for in the ease of the relationship. On the contractor’s side, there are also benefits, such as being able to claim business expenses, and being able to work for multiple clients.

Downsides of Using Contractors

The lack of complete loyalty can be a disadvantage when you use contractors, and there is also potential time conflicts as the contractor may work with multiple clients simultaneously. You also have an investment in bringing the contractor up to speed, but then you lose that investment when the contract is done.

The greatest risk, however, is the IRS tax issue. If a contracting arrangement does not meet the IRS guidelines for contractors versus employees, your company is liable for the back taxes, and penalties.

IRS Guidelines

The IRS guidelines have continuously evolved and been tightened over the past three decades. Their website is quite exhaustive, and they have a cadre of lawyers whose sole job is to enforce and litigate this area.

The test for a contractor versus employee covers three broad areas. Here’s what their website states:

  1. Behavioral: Does the company control or have the right to control what the worker does and how the worker does his or her job?
  2. Financial: Are the business aspects of the worker’s job controlled by the payer? (these include things like how worker is paid, whether expenses are reimbursed, who provides tools/supplies, etc.)
  3. Type of Relationship: Are there written contracts or employee type benefits (i.e. pension plan, insurance, vacation pay, etc.)? Will the relationship continue and is the work performed a key aspect of the business?

Each of these areas is spelled out in more detail on the IRS Website. Be sure you have followed the intent of the guidelines, so that there are no surprises later for either you or the contractors.

Note that your state may also have its own definitions and legal guidelines. A good source of help can be your HR firm, if you have outsourced to someone such as TriNet. They offer checklists and guidance for making the right determination.

For more helpful information, read this article.

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