Working with independent contractors can be a smart business practice. But you need to understand how to do it the right way. In the eyes of the IRS and Department of Labor (DOL), these workers must meet certain criteria that distinguish them from employees. Get it wrong and you run the risk of having to pay back taxes – and face other stiff penalties.
Now you might be thinking, “The government isn’t going to come after me for misclassification.” And you’re probably right. Agencies don’t have the resources to investigate the millions of U.S. businesses. However, that’s not your biggest concern.
Workers don’t always understand that being an independent contractor means they can’t file for unemployment or make a workers’ comp claim if they get hurt on the job. All it takes is for one of these workers to contact one government agency. Once the agency finds out that a business is misclassifying workers, it will open up a much broader investigation.
And then there’s a risk of a disgruntled worker filing a report. The IRS has a special form – Form SS-8 – any worker can submit to request a classification review.
If you are ever investigated, you want to be sure you’ve established a legal independent contractor relationship with the worker. Here are five common mistakes employers make:
1. You assign employees to help the contractor.
You’re using a contractor for a big project. To help speed up the process, you ask a few employees to lend a hand. No problem, right? Well, it could be. Independent contractors are responsible for getting the work done. If they need help, they should bring on their own helpers or support workers. Employers should remain relatively hands off, letting the contractor determine what resources he or she needs to complete the job.
2. You give the contractor a dedicated workspace.
Your independent contractor has been spending a lot of time at your business. You have an empty office so you allow the contractor to use it whenever he or she is in the office. While this might seem like a nice thing to do, it’s actually a possible sign of an employee relationship. Contractors are vendors; they shouldn’t have a desk at your company.
3. You provide paid time off (or other benefits).
Although it’s recommended that you pay by the project, many businesses pay independent contractors an hourly fee. That’s not necessarily a deal breaker – although it can be a red flag. But an even bigger indicator of an employee relationship is if you give your contractors paid time off for vacations, sick days or holidays. Providing benefits of any kind more likely signals an employee relationship.
4. You work with the contractor on a long-term basis.
Contractors should be tapped for specific projects. And those projects should have set, agreed-upon end dates. If the relationship is open-ended, it could spell trouble. The more permanent the relationship, the more likely it’s considered an employee relationship. It’s best not to use contractors full-time or for an extended period of time.
5. You have the contractor perform core business functions.
Contractors should provide supplemental services but shouldn’t be an integral part of your business. For example, if you use a contractor to build a website for your construction company, that’s not a core business service. But if your business is designing websites – and your web designers are independent contractors – that could be a problem.
It’s important to note that no single factor determines contractor or employee status. It’s the totality of the circumstances which matters. In general, you want to have as few red flags as possible.
Besides avoiding the missteps listed here, the best way to protect your business is to have a signed agreement. And you should call it an “Independent Contractor Agreement” so there’s no question about the intent of the relationship. The agreement should specify how much you’re going to pay, and under what terms. It should also specify an end date, or at least tie the end of the contract to the completion of a specific project. For a sample agreement and other information on classification, click here.
Additionally, before any work begins, you should receive a Form W-9 from your contractor. Then, you will need to file a 1099-NEC for the year if you have paid an independent contractor $600 or more for services. The 1099-NEC will be used beginning in calendar year 2020, replacing the 1099-MISC*. When you’re ready to file your 1099-NEC forms, look no further than efile4Biz. It’s the fastest, easiest way to get copies of the forms to your contractors and electronically file with the IRS.
*1099-MISC forms are still in use by the IRS; however, they are no longer used for independent contractor payments.