It might be tempting to pay an independent contractor versus an actual employee to avoid taxes. However, there are many factors to consider in order to decide if this is the correct path for your small business.
By Tim Dimoff
I previously offered tips for a small business that is hiring summer help. To expand on that subject, this month I will discuss the differences between hiring an employee and hiring an independent contractor. You might pay an independent contractor and an employee for the same or similar work, but there are key legal differences between them. It is critical for you as a small business owner to correctly determine whether anyone providing services to you is correctly classified as an employee or an independent contractor.
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It is important that you correctly identify employees and independent contractors. This is crucial because if the government concludes that you should have defined someone as an employee and not as an independent contractor, then you are still liable for their payroll taxes. The important distinction is the relative independence of the position. If you are in doubt, you can always document the situation in a Form SS-8 and submit it to the IRS for an opinion.
To clearly define a contractor, consider how they deliver their work product. A contractor does not receive any benefits that you would normally pay to an employee and they do not receive overtime compensation. It doesn’t matter if you pay them hourly or a fixed amount for their work, however an independent contractor should not be paid through your payroll system. You should always pay them through your accounts payable system. And you must provide them with a Form 1099 at the end of the calendar year. They are responsible for paying their own payroll taxes to the government.
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In contrast, an employee is anyone who performs services and are under your control. The important part is that you have the right to control the details of how their services are performed, hours worked etc. They are paid through your payroll system and you are responsible for withholding payroll taxes and remitting these taxes to the government. Employees can also can receive benefits like vacation pay, overtime, insurance, etc.
Whether a worker is an independent contractor or an employee depends on the relationship between the worker and your business. The IRS uses the following three criteria to establish whether someone is an employee:
- Behavioral control − Does your company control or have the right to control what the worker does and how the worker does the job?
- Financial control − Does your business control the financial and business aspects of the worker’s job? This includes how you pay the worker, how you handle expenses and if you are providing supplies, tools, etc.
- Relationship of the parties – Do you have a written contract or are you providing employee benefits such as pension plan, insurance and vacation pay?
As a business owner, you should make the decision if they are an employee or an independent contractor based on the sum total of all of the above factors. While it may be tempting to classify workers as independent contractors to avoid paying payroll taxes, you must correctly identify them in order to avoid any government penalties.
President, SACS Consulting & Investigative Services, Speaker, Trainer, Corporate Security ExpertTimothy A. Dimoff, CPP, president of SACS Consulting & Investigative Services, Inc., is a speaker, trainer and author and a leading authority in high-risk workplace and human resource security and crime issues. He is a Certified Protection Professional; a certified legal expert in corporate security procedures and training; a member of the Ohio and International Narcotic Associations; the Ohio and National Societies for Human Resource Managers; and the American Society for Industrial Security. He holds a B.S. in Sociology, with an emphasis in criminology, from Dennison University. Contact him at info@sacsconsulting.com.
