Is your “Contractor” really independent?

“Just skip the payroll taxes and expenses, pay your worker’s straight pay and send them a 1099!” I’ve even heard other accountants say those exact words to employers, so when I’m advising a small business owner and they recite this money-saving strategy, I have to blow the whistle and at least throw out a caution flag (is that soccer, or NASCAR?). That’s what accountants do; we can’t help it.

But seriously – did you know that there are rules and guidelines that the IRS uses to determine if someone is an “employee?” There is room for interpretation, which gives you a little bit of flexibility, but the way you do business and how you work with the contractor/employee is what the IRS will examine if they ever decide to take a closer look at your business returns. Here are the three main areas of concern:

1. Behavioral Control. Who directs and controls what work is done and how it is done? Do you provide instructions and training? Do you determine where supplies and materials are purchased?

2. Financial Control. Does your worker pay any of their expenses, or do you reimburse them? Do they provide their own tools? Does the worker have other jobs or make himself/herself available to others in the market? Is it possible for the worker to sustain a loss in the work?

3. Relationship. Is the agreement in writing? Are there benefits in addition to pay – such as insurance or sick pay, like an employee relationship? Is the relationship defined for a specific time period, or is it open and permanent? Are the services that the worker provides a key aspect of the business?

That’s a lot of question marks, and I can’t tell you that one specific question will be the one that matters. Some of your answers to these questions may point to employee status, while others might indicate your worker is independent. The entire relationship has to be considered and, just being straight with you – as you looked through these questions, you probably already know if it quacks like a duck, right?

If both you and your worker are agreed that they are independent, one of the most helpful things you can do for yourself is to document the relationship. At the very least, collect a signed W9 form from your worker. Find a good Independent Contractor Agreement template online and customize it so that it fits your situation. That agreement, signed by both parties, goes a long way in defining the relationship – as long as the facts and circumstances of the work are reflected accurately in the agreement. Better yet – consult a legal professional to make sure that agreement is properly drafted. Pay the attorney fees, skip the penalties and fines and interest and taxes.

Why the fuss? If you classify someone as an independent contractor and it turns out they really aren’t independent, you may be liable for the employment taxes for that worker during the entire time of their employment. That math can really add up, with penalties for late payment and interest compounding. Not only the FICA employment taxes (15.3% of gross pay), but also the required federal and state withholding. And you don’t get to go back to the worker to collect it – it’s all your responsibility as the employer.

Sending out the 1099s to your independent contractors at the end of the year is also very important, and it carries its own fines and penalties if not done properly. Keeping these relationships defined properly and documented can help you focus on your workplace and workflows, and it can save you some tax and legal expenses in the long run as well.