Consultant’s Corner: Considerations for Engaging Independent Contractors
Q: I’m thinking about engaging an independent contractor. What do I need to know before I start?
It is important to understand that there is no worker classification known as a “1099 employee.” Workers are either classified as employees or independent contractors. Compensation for services rendered by workers classified as employees is reported on Form W-2, whereas compensation for services rendered by workers classified as independent contractors is reported on Form 1099-MISC. Employers have federal and state payroll and unemployment tax, workers’ compensation and labor law considerations with workers classified as employees. In contrast, workers classified as independent contractors pay their own payroll taxes and insurances, and are not subject to most labor laws.
An independent contractor is a legal category of worker defined by the Internal Revenue Service. In accordance with IRS rules, independent contractor status is not an arbitrary election that the party engaging the worker or the worker can make, but is based on a worker’s job and the level of control the party who engages the worker exerts over how the worker performs that job. The more control exercised over how, when, where, and by whom work is performed, the more likely workers are employees rather than independent contractors.
When engaging a worker as an independent contractor, it is advisable for the party engaging the worker to have the worker complete Federal Form W-9, to draft and have the worker execute an independent contractor agreement that outlines the terms of the arrangement between the party and the worker, to obtain documentary proof from the worker supporting any required business or professional licenses and liability and/or workers’ compensation insurance, and to prepare copies of Federal Form 1099-MISC to report the compensation paid to the worker to the IRS and state tax authorities when required. However, no documentation that you have a worker complete or request from that worker will qualify the worker as an independent contractor. To avoid the negative repercussions of misclassifying their workers, employers must look closely at the facts of their relationship with workers they engage as independent contractors to ensure they are properly classified as independent contractors in accordance with IRS and state tax and labor law rules.
Misclassifying workers as contractors can have labor law, employee benefits, employment tax, and workers’ compensation implications for businesses and the affected workers. For example, making the wrong determination of a worker’s status can result in IRS and state tax audits with back tax assessments that can be ruinous to a small business; therefore, it is important that a business owner understand the criteria that the IRS and state authorities use in determining whether a worker is properly classified as an employee or an independent contractor. To develop a better understanding of the risks, you can review discussions on the topic at websites like the following:
Improperly Classifying Employees as Independent Contractors: What are the Penalties? – JustWorks
IRS Worker Classification Audits—Risks and Relief Options – Ogletree Deakins
Misclassification of Employees as Independent Contractors – U.S. Department of Labor
In order to determine whether a worker qualifies as an independent contractor rather than an employee, the worker’s job and the control you exert over the worker must be evaluated under what is known as the common law right of control test. Under this subjective test, for which the IRS developed a 20-factor analysis for its auditors, the IRS basically takes the position that if you tell a worker what to do and how to do it, then that worker is an employee. To add to the classification difficulty, state government agencies often use different criteria than the IRS for classifying workers as employees or independent contractors for state tax and workers’ compensation purposes and some states can impose severe penalties under state law on businesses that misclassify workers as independent contractors.
You can review the IRS criteria for determining whether your workers are properly classified as independent contractors at the websites below. Since the potential penalties for misclassifying a worker as a contractor rather than an employee can be severe, if you are uncertain about the proper classification of your workers, you should review the details of their responsibilities with your lawyer to assure that you handle the compensation, payroll taxes, and insurance in accordance with labor and tax regulations.
Independent Contractor (Self-Employed) or Employee? – IRS
Employer’s Supplemental Tax Guide – IRS (see – 2. Employee or Independent Contractor?)
Using Independent Contractors & Freelancers Article Directory – Nolo
