One of the ways that some businesses use to control costs and stay “flexible” is to hire independent contractors.
Generally speaking, independent contractors don’t receive health insurance benefits, workers compensation coverage, 401(k) retirement contributions and several other benefits that employees typically receive. Businesses also don’t have to contribute the “employer’s portion” of social security and medicare contribution.
Further, it is usually easier to terminate independent contractors as they typically work until a project is completed or under the very specific terms of a contract. In “at-will” employment states like Texas, this is less of a factor, but in some other States employers have much less leeway in terminating employees.
Some individuals prefer to work as independent contractors because they feel less constrained or bound to a particular employer and they can also deduct more of their expenses for tax purposes.
The IRS is concerned about situations where employers classify individuals as independent contractors when they really should be treated as employees. Sometimes businesses need to be concerned not only about the IRS, but also state workforce agencies because sometimes individuals classified as independent contractors file for unemployment benefits when their employment as an independent contractor ends.
See the IRS (20-factor) guidelines here…
This is usually where the trouble begins. If the IRS or a state agency finds that your company has been treating workers as independent contractors when they should have been treated as employees then they go after not only the taxes and benefits that should have been contributed, but also penalties. In some situations the penalties can be stiff.
The issue is control. If the IRS or state employment agency finds that the employer is controlling the manner in which the worker is doing their job then they will likely find that the worker is an employee and not an independent contractor.
One of the things that the IRS looks at is the existence of a written contract. The independent contractor’s contract must have some very specific language and it must be understood and agreed upon by all the parties.
Check out CFO Magazine’s writeup on the upcoming IRS crackdown.
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