With regards to a recent article in the Atlanta Journal and Constitution, the entire area of Independent Contractor versus an Employee in a Small Business involves a number of issues. Below is overview of the basic issues and pitfalls that relate to this area:
– While it is less expensive to engage a person as an independent contractor versus an employee, depending on what fringe benefits are being offered to an employee, the savings are generally only 10% to 30% of their hourly rate, and not worth it to get in trouble with the IRS or your state Department of Labor.
– The business is the one that has to pay the current unpaid FICA taxes and Federal and State Unemployment taxes, back taxes, interest and penalties when a person is found to be misclassified as an independent contractor when they are in fact an employee.
– IRS has approximately 20 rules which appear in several places in the IRS regulations that it uses to determine whether a person is an independent contractor or an employee.
– When evaluating the rules, the subject person does not to need to be all or none of these; it is preponderance of the rules (i.e. 16 versus 4 or 13 versus 7).
-Some of the approximately 20 rules are more important than others. For instance, the person’s ability to make a profit or a loss supports a person being an independent contractor rather than an employee, because an employee can never lose money by working for you, whereas someone who has their own “business” can lose money.
– Having a person sign an independent contractor does not hold any weight, because IRS will disregard any “contract” or “agreement” and look to the true substance of the relationship.
– While each state’s rules which it uses to determine if a person is an independent contractor or an employee differ from the IRS rules, generally if you comply with the IRS rules, you will comply with the state rules because the IRS’s rules are typically more comprehensive than the state’s rules .
– Many times the independent contractor or an employee situation is discovered when a person who is being paid as an independent contractor applies for unemployment and a state Department of Labor opens an investigation.
-Many times a business does not save any Workmen’s Compensation costs because very often they are required to provide Workmen’s Compensation coverage to both independent contractors and employees.
– Some industries, such as construction have a long standing precedent of being able to treat some of their personnel as independent contractors.
Planning is Necessary for Using Independent Contractors or Employees in a Small Business
Because of the complexity of this area, it is highly advisable to look for a CPA who knows the IRS and your state rules and how to apply them in your business’ situation in order to plan properly for your small business and keep you out of trouble with various tax authorities.