Hiring new employees is not something many of you had to concern yourselves with for the last couple of years. Most of you have been busier with the nasty task of laying off people for whom there was not enough work.
Slowly, the economy is coming around and work is picking up or soon will be. That will present a dilemma for many of you. Do you hire extra help to make sure you’re staffed for an increased workload - keeping in mind there might be some training required and time to navigate a learning curve? Or do you risk missing out on the upturn because you can’t handle much more volume?
A tempting middle ground is to subcontract work to people you can use as much as needed but who won’t burden your payroll if you don’t get a sustained increase in workload. By hiring independent workers on a temporary or job-by-job basis you don’t have to worry about tax withholdings, workers’ comp, unemployment compensation and messy layoffs if work slows down again. These costs add about a third to the expense of hiring a captive employee. That’s why it’s an attractive proposition to hire people on a pay-as-you-go basis.
In fact, so many contractors are trying it out the Internal Revenue Service has undertaken a widely reported crackdown on abuse of independent worker status, and many individual states have joined the battle as well. If you’re caught on the wrong end of one of these investigations, you could be held liable for many thousands of dollars in back taxes and penalties.
The IRS itself looks at three basic areas to determine if someone is a regular employee or independent worker.
1. Behavioral:Does the company control or have the right to control what the worker does and how the worker does his or her job?
2. Financial:Are the business aspects of the worker’s job controlled by the employer? These include things like how worker is paid, whether expenses are reimbursed, who provides tools/supplies, etc.
3. Type of relationship: Are there written contracts or employee type benefits (i.e., pension plan, insurance, vacation pay, etc.)? Will the relationship continue and is the work performed a key aspect of the business?
These are only broad guidelines as to what constitutes an independent contractor. The devil is in the details, of which there is no shortage. For instance, the IRS offers these guidelines for behavioral control factors:
• Type of instructions given- when and where to do the work; what tools or equipment to use; what workers to hire or assist with the work; where to purchase supplies and service; what work must be performed by a specified individual; what order or sequence to follow when performing the work.
• Degree of instruction- the more detailed the instructions, the more control the business exercises over the worker. More detailed instructions indicate that the worker is an employee. Less detailed instructions reflect less control, indicating that the worker is more likely an independent contractor. However, according to the IRS, “The amount of instruction needed varies among different jobs. Even if no instructions are given, sufficient behavioral control may exist if the employer has the right to control how the work results are achieved. A business may lack the knowledge to instruct some highly specialized professionals; in other cases, the task may require little or no instruction. The key consideration is whether the business has retained the right to control the details of a worker’s performance or instead has given up that right.”
• Evaluation system- “If an evaluation system measures the details of how the work is performed, then these factors would point to an employee. If the evaluation system measures just the end result, then this can point to either an independent contractor or an employee.”
• Training- “If the business provides the worker with training on how to do the job, this indicates that the business wants the job done in a particular way. This is strong evidence that the worker is an employee. Periodic or ongoing training about procedures and methods is even stronger evidence of an employer-employee relationship. However, independent contractors ordinarily use their own methods.”
The IRS goes into similar detail discussing the financial and relationship parameters, which I’ll dispense with in the interest of saving a forest full of trees. If you’re not confused enough and are having trouble falling asleep, pay a visit to www.irs.gov/pub/irs-utl/emporind.pdf and check out the IRS’s 160-page training manual instructing its staffers titled “Independent Contractor or Employee?”
According to the IRS, “there is no ‘magic’ or set number of factors that ‘makes’ the worker an employee or an independent contractor, and no one factor stands alone in making this determination. Also, factors which are relevant in one situation may not be relevant in another. Businesses must weigh all these factors when determining whether a worker is an employee or independent contractor. Some factors may indicate that the worker is an employee, while other factors indicate that the worker is an independent contractor.”
So sayeth the IRS.
Even though they have trouble figuring out whether someone is an independent worker or employee, that doesn’t excuse you from making the distinction. For instance, whether you’re supervising an employee or an independent worker, you need to insist that whoever you hire has got to perform a certain job task in accordance with your standards and procedures, and must adhere to a work schedule determined by a customer and jobsite conditions.
These concern the results of job performance, and the IRS probably wouldn’t nail you on that alone. But if you get too specific about how the worker has to do the job in order to achieve those results - i.e., “my way or the highway” - you could be leaving yourself vulnerable. In other words, you have the right to direct what must be done, but not how it must be done.
Unless, of course, they decide to look the other way. Which they might do, because, as noted, “factors which are relevant in one situation may not be relevant in another.”
Some experts think certain factors are more of a slam-dunk than others when it comes to defining an independent contractor. One is incorporation. If someone you hire has incorporated his business, it’s thought to be unlikely the IRS will question the independent status. It’s also beneficial if the independent contractor can point to other clients besides your firm.
Another strong indicator is a written contract that specifies the performance expectations, just as your company performs works under contract. The only catch here is that it’s pretty easy to compose a sham contract that appears to establish independence but whose terms impose specific obligations more characteristic of direct employment.
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.
If you have a real lot of time to kill, you can learn more about the critical determination of a worker’s status as an independent contractor or employee at www.IRS.gov 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).
Or, you can roll the dice by following your gut instincts and take your chances.