Business Owners: You just hired someone to perform a service for your business. Is it an employee or an independent contractor?
The key is to understand the business relationship that exists between you and the person performing the services. Sound like a trivial accounting issue? It’s not. But many business owners who rely on contingent labor make this mistake in wanting to minimize employer payroll tax expenses on their P&L. While the practice sounds economical and affords flexibility, it can lead to tax and legal problems if certain requirements are not managed carefully.
Here is how you can stay out of legal and tax trouble. According to the IRS, there are three key factors to examine:
- Behavioral: are you controlling HOW the person performs the service or provides the deliverable? Or do you just care about the end result? If you are hiring a contractor, you should not have to spell out exactly how you want the person to deliver the result you are looking for. You just want them to get it done. Too much oversight and instruction, and you have an employee on your hands!
- Financial: does this person market themselves to other businesses to perform similar services? Has this person made a significant investment in equipment, systems, or even education in order to perform the services you need? Do they have an opportunity to make a profit for the services they provide? If the question is yes to all of these, you more than likely have a contractor.
- Type of relationship:
- Do you and the person assume that the relationship continues indefinitely, rather than for just a specific project or time frame? For example, if you hire a project manager to run a major system implementation for your business and there is no time frame or definite deliverable, this is an employee.
- Does this person perform services that are a normal part of your everyday business? For example, as a CPA, if I hire someone during tax season to help me with tax returns, that is what my business specializes in. So that person is an employee, not an independent contractor. Conversely, if I hire someone to run cabling in my office to network all of my machines together to prepare for tax season, they are a contractor. Not an employee
If in doubt, it is wise to execute a written contract with each independent contractor you use. The document should spell out that he or she is a contractor, and outline the work that will be completed by him or her—but it should not get into how that work will be completed. This document will not, by itself, keep you out of trouble. The IRS and government will review the 3 points listed above and make a decision.
Or, just call me, your CPA! I will guide you to whatever the right decision is for your business, your contractors and your employees.