Independent Contractors – Know the Rules

Businesses are always looking for ways to save money and should be. Unfortunately they often choose a method that may come back to haunt them.

So You Want to Give Employees a Break?

Years ago I was joined a company that paid some of its employees a draw and commissions on top of that. For this they were treated as employees and the applicable taxes deducted and remitted along with the company’s portion of taxes. However, this company also paid these same employees a rather sizable auto allowance as if they were an independent contractor. This they reported on a 1099-MISC and deducted no taxes or paid company taxes. Unfortunately, I had to inform them that the nature of this payment was actually taxable compensation and had to be taxed as an employee. They did file amended payroll tax returns to correct this issue. Had they not they could have opened themselves up to substantial penalties.

But We’re Trying to Save Money

Please see the last sentence. You are likely to get an unpleasant surprise and owe additional taxes, penalties, and interest. Business management and owners may even find themselves subject to personal liability. No, you are not saving money by classifying someone who is really an employee as an independent contractor. Rather, you are creating a future headache that may prove costly.

Why Can’t I Make Them Independent Contractors?

It actually gets rather involved, but there are several rules that the Internal Revenue Service looks at to determine whether someone is an independent contactor or employee. These are known as Common Law Rules. These fall into three categories as follows:

BEHAVIORAL CONTROLBehavioral control involves whether a business can instruct a person about when, where, and how to work. This has a number of areas that are looked at, such as tools and equipment used, hiring of workers to assist with the work, whether a specific individual must perform the work, training provided, and a host of other things. It gets rather involved to say the least.

FINANCIAL CONTROLFinancial control includes such things as the extent to which a worker will have unreimbursed business expenses, the extent of the worker’s investment, does the worker makes his or her services available to the general market, and how the individual is paid. This last one (how the person is paid) can be confusing.

TYPE OF RELATIONSHIPType of relationship includes such things as written contracts, whether benefits are provided, the permanence of the relationship, and the extent to which the services performed are a key aspect of the regular business of the company. Again, this area can be difficult when making a determination of status.

The bottom line is, if you are in doubt, consult your attorney. Alternatively, you can ask the IRS to make a determination by filing Form SS-8, Determination of Worker Status for Purposes of Federal Employment Taxes. Suffice it to say, you are better off paying a little extra taxes from the beginning of a work relationship than finding out later that you misclassified someone as an independent contractor and now owe back taxes, penalties, and interest.

If you want to know more, contact AimCFO – Contact

As always, your comments are welcomed.

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