Saturday, December 12, 2009

Employee vs. Independent Contractor – Ten Tips for Business Owners

This article was written by Bern Lefson, SCORE Orange County Management Counselor

clip_image001All too often we find employers upset with the high cost of workers’ compensation and associated employee costs who decide to employ Independent Contractors. While the perceived incentive of lower cost is attractive, this decision can put an employer out of business. Both the State and the IRS are seeking revenue and this area is ripe grounds for additional revenue.

The most significant potential liability of worker misclassification is back federal, state and local payroll tax withholding (e.g., FICA and income tax). The IRS has made reviewing employee misclassification a priority when conducting audits. Other potential liabilities include overtime, benefits, and unemployment compensation.

The IRS does aid small and large businesses by posting the rules and tips on its website. Below is one of those tips that may assist you in avoiding fines, penalties and bad publicity.

Here are the top ten things every business owner should know about hiring people as independent contractors versus hiring them as employees.

1. Three characteristics are used by the IRS to determine the relationship between businesses and workers: Behavioral Control, Financial Control, and the Type of Relationship.

2. Behavioral Control covers facts that show whether the business has a right to direct or control how the work is done through instructions, training or other means.

3. Financial Control covers facts that show whether the business has a right to direct or control the financial and business aspects of the worker's job.

4. The Type of Relationship factor relates to how the workers and the business owner perceive their relationship.

5. If you have the right to control or direct not only what is to be done, but also how it is to be done, then your workers are most likely employees.

6. If you can direct or control only the result of the work done -- and not the means and methods of accomplishing the result -- then your workers are probably independent contractors.

7. Employers who misclassify workers as independent contractors can end up with substantial tax bills. Additionally, they can face penalties for failing to pay employment taxes and for failing to file required tax forms.

8. Workers can avoid higher tax bills and lost benefits if they know their proper status.

9. Both employers and workers can ask the IRS to make a determination on whether a specific individual is an independent contractor or an employee by filing a Form SS-8 – Determination of Worker Status for Purposes of Federal Employment Taxes and Income Tax Withholding – with the IRS.

10. You can learn more about the critical determination of a worker’s status as an Independent Contractor or Employee at by selecting the Small Business link.  Additional resources include IRS Publication 15-A, Employer's Supplemental Tax Guide, Publication 1779, Independent Contractor or Employee, and Publication 1976, Do You Qualify for Relief under Section 530? These publications and Form SS-8 are available on the IRS Web site or by calling the IRS at 800-829-3676 (800-TAX-FORM).