Are you making the mistake that will bring the IRS to your business? Independent Contractor versus Employee

The perfect storm of the Affordable Care Act and the lingering effects from the financial crisis have combined to force many businesses and non profits to make tough decisions on whether to hire or keep current employees, or to work with Independent Contractors. Many businesses have gone the independent contractor route but does their classification of workers as independent contractors pass the IRS test?



A recent Wall Street Journal Article (subscription required) reported that roughly 1 in 3 U.S. Workers, is now a freelancer. That is 53 million Americans that are employed as Independent Contractors and temporary employees. But should they be classified that way? 

Companies laid off thousands of workers during the recession of December 2007 through 2009 and have not hired full time workers back at the numbers normally associated with a recovery. Why? In some  cases companies developed greater efficiencies and did not need them.

Of course one of the big reasons for the lack of hiring today is the Affordable Health Care Act (Obamacare). Many companies have either reduced workers hours to under 30 per week to avoid counting as a full time worker or, increasingly, by hiring independent contractors.

But are these workers truly independent contractors? The IRS is increasingly scrutinizing these arrangements. Look for that pressure to increase as the oft delayed regulations from ACA take effect. In particular the requirement to provide health insurance to employees or pay a larger per employee fine will be aggressively pursed by the IRS.

So what classifies a worker as an independent contractor versus an employee? The IRS offers guidance based on evidence of the degree of control and independence of the worker.

The 3 main factors determining the degree of control and independence

1. Behavioral. Does the company control what the worker does and how the worker does the job. Factors looked at include:

* Can the work be assigned to others?

* The degree of instruction

* How the work is evaluated

* Training – if the employer provides the training, you are probably an employee.

2. Financial. This includes how the worker is paid, whether expenses are reimbursed, and who provides the tools needed for the job. Also considered is whether the worker can make a profit or loss on the job.

3. The Type of Relationship. Are there written contracts? Are benefits provided? Will the relationship continue after a specific job is completed? Can the employer fire the worker or can the worker quit at any time without financial consequences? Are the workers services available to the general public?

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Why it matters for Employers

The IRS is looking for employers that are trying to avoid paying payroll taxes and their responsibilities under the affordable care act. The penalties for back taxes can be pretty steep. They include the employer share of social security and medicare, tax penalties on not providing health insurance (when ACA finally goes into effect), unemployment insurance payments, failure to withhold taxes from the employees, and other penalties.

Why it matters for Workers

Independent contractors are responsible for their own quarterly tax withholdings. This includes social security and medicare taxes (called self employment tax) and income tax withholding. The worker also must file a separate tax form, IRS Schedule C – Profit and Loss from Business, when she does her annual taxes.

If you are unsure of how to classify your workers, see your tax accountant and avoid the risk of IRS issues.

Question: Are you employing an independent contractor instead of employees? What are the benefits and risks of hiring independent contractors? Are you an independent contractor that should be an employee and eligible for benefits?