With the down economy, many companies have eliminated jobs and turned to independent contractors to trim costs. However, it is not up to the business or the worker to decide who is a contractor and who is an employee. The IRS is the ultimate arbiter, and failure to follow its rules can be financially painful to a business.
By using independent contractors, businesses can retain flexibility when workloads are cyclical or sporadic, buying only as much labor as is needed. And, many legal burdens of the typical employer-employee relationship can be avoided. Furthermore, workers themselves may prefer to be contractors rather than employees because as contractors, they have more freedom and enjoy being their own bosses.
The decision to classify a worker as an employee or a contractor depends on the facts and circumstances of each case. To determine if a worker is an independent contractor or an employee, tax officials examine the relationship of the worker and the business, scrutinizing whether that relationship is one of control or true independence. Evidence of the degree of control a worker might have falls into three realms: behavioral control, financial control and the type of relationship in general.
Behavioral control encompasses how the work is to be done. Questions that are considered are: Who controls where and when the work is to be done? Who provides the tools or equipment or makes the decision of what supplies are needed? Does the worker have the right to hire assistants? Who provides the training?
Financial questions include how the worker is compensated. An employee is usually paid hourly, weekly or monthly. A contractor is typically paid by the job or contract. Questions also include whether the company provides the worker with employee-type benefits such as health insurance, vacation pay, sick pay or contributions to a retirement plan.
Lastly, in classifying workers, the IRS explores the type of relationship between the two parties. How permanent is the relationship between the worker and the company? Is the worker performing a one-time service for the company or are the services performed an integral part of the company’s daily business? How much control does the hiring company exercise over customer selection, work schedules and rules, or work performed outside the relationship?
The distinction between contractor and employee is not just in name. Businesses face significant financial repercussions for both intentional and unintentional erroneous classifications of workers.
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