Every small business owner has to determine if s/he is going to need assistance with their workload. There are some very complicated – and expensive – regulations for having employees, so some companies try to dodge the financial bullet by hiring independent contractors.
However, if you are going to go the Independent Contractor (IC) route, I strongly recommend that you be clear about the definitions and the difference. Because if you classify an employee as an independent contractor and you have no reasonable basis for doing so, you may be held liable for employment taxes for that worker — and that’s just the tip of the iceberg.
Here are seven warning signs that your independent contractor is really an employee:
- Doesn’t have a business name. ICs are, by definition, business owners. If your IC doesn’t have a business name, how do you know he has a business at all?
- Doesn’t maintain a separate business checking account. If you are being asked to pay your IC cash or she insists on checks made out to her personally, this is a red flag. Make sure that your bases are covered by requiring a W-9 and issuing a 1099. When you pay an IC more than $600 for services within one calendar year, you are required by the IRS to issue a 1099 tax form. The W-9 form is used by ICs to report their tax identification numbers to their employers for tax purposes. You say your IC doesn’t have a tax ID number? Another red flag…
- Doesn’t advertise his/her business’ services. As a business owner yourself, you know the only way to generate more business is to advertise. If you are your ICs only ‘client,’ watch out!
- Does not invoice for work completed. ICs should invoice you project by project. Ideally, the invoice has the independent contractor’s business name and address on the form. Employees do not submit invoices for their work.
- Work hours are set by you. Does your IC work the same hours every week at an hourly rate? Then you’ve hired an employee!
- You supply all necessary materials, equipment, and tools. You should not be paying the IC’s costs; it’s up to the IC to make sure that his or her costs are covered by the agreed upon payment for the project for which s/he is hired.
- Doesn’t keep business records. An employee doesn’t have much to keep track of, since you, as the employer will send a W-2 at the end of the year to show what wages were paid as well as taxes that were deducted. ICs, however, need to keep track of income as they earn it, along with any expenses related to their job, and may need to pay taxes in advance through quarterly estimated taxes. You may or may not be aware of your IC’s record keeping, but it is to your advantage to set up your own files for each and every independent contractor. In those files, you will want your IC’s business cards, ads, copies of invoices and record of any communication. These files can prove that the ICs have their own business reputation and that you are in compliance with regulations.
I have structured my business to do without employees as much as possible. However, there were times when I could not continue without hiring some folks to help me. During those times, I went straight to my CPA for help in setting up the entire payroll recording, withholding and reporting systems. All I had to do was to write the employee checks that my accountant told me to write. His service, in my opinion, was worth the cost.
Well there you go sports fans. Don’t try to mess with or stretch the definitions. Bite the bullet if you have to have employees and abide by the letter of the law for having them.
What has been your experience with independent contractors versus employees? Let us know in the comments.