Strategies to ensure workers are properly classified as contractors
There are many advantages of hiring an independent contractor instead of an employee. The advantages include the reduction in payroll taxes, workers compensation, and benefits. However, the IRS definitions for the difference between a contractor and an employee can be cloudy.
Failure to correctly classify workers can result in substantial penalties from the IRS and other government agencies. Consequently, it’s critical to ensure that these government agencies won’t disagree with your classification in the event of an audit.
To avoid an independent contractor being reclassified as an employee, it is advantageous to use the following strategies.
Document your business’s policy for determining whether a worker is a contractor or employee. This shows that your organization uses guidelines it follows rather than basing the decision on how it provides the most benefit to the company. Your policy should detail the qualifications it uses to determine the proper relationship. It’s advantageous to include the guidance on the IRS website to set your policy.
Don’t make the mistake of giving your contractor your business cards. It may seem harmless but independent contractors should never represent themselves as part of your organization. If a contractor has its own business cards it helps to prove that it is not part of your company. Their cards should not include your organization’s logo or any of your other business information.
Hire independent contractors whose business is structured as an LLC, corporation, or partnership. Hiring a sole proprietor who is structured as an LLC provides an additional factor to help establish that they have their own business.
Avoid paying an independent contractor on a fixed or regular basis. Paying them on a project basis or a percentage of completion basis helps to indicate that they are a contractor. Employees are normally paid an hourly wage or salary.
Having them invoice you for their services will help to establish that they are an independent contractor. Employees may turn in an expense report for reimbursement, but they don’t invoice their employer for their services.
Hire independent contractors who work for other businesses. If your contractor works for other companies, it helps to prove they are in business for themselves. The more businesses your contractor works for the more obvious it becomes that they are not your employee.
Avoid thinking that you won’t get caught. If a contractor feels like they are entitled to be treated an employee, they could turn you in to make you responsible for their payroll tax. Or they could report you if your relationship deteriorates.
If you misclassify a worker, it could be extremely costly since you could be forced to pay huge penalties from the IRS and other government agencies. It’s important to know the IRS rules for classifying a worker and use as many strategies as possible to make your case.
David Zubler has an accounting degree and computer science degree with high distinction and has experience as an accounting manager and controller in manufacturing, and has owned his tax/consulting business since 1990. David Zubler is the founder and president of Your Tax Care. The company provides business and tax education to the public at its website, YourTaxCare.com. David can also be contacted by email at firstname.lastname@example.org.