The Castleman Law Firm
Q: I need more help in my business, but I don't want the hassle and aggravation of hiring employees. Is it smart to hire people as independent contractors?
A: This is a very hot topic today. The paperwork, taxes, and liabilities involved in having employees have caused many employers to hire individuals as "independent contractors" rather than as employees. However, the Internal Revenue Service is cracking down on these employment arrangements and reclassifying many of these workers as employees. A contract between you and an individual which classifies the worker as an independent contractor, even if the worker wishes to be an independent contractor, will not protect the business owner from reclassification by government authorities.
The downside of such a reclassification by IRS to the small business owner is that the IRS may assess additional taxes on the business up to the amount that should have been withheld from the employee's pay. In addition the business may be liable for penalties for improper classification, failure to file returns and the 100 percent penalty for willful failure to collect taxes - plus interest.
The stakes are high, so consult your attorney before you enter into one of these independent contractor arrangements with a worker. An easier way might be to look into "leasing" workers from one of the many worker leasing companies which have started to appear in recent years. These companies take on the responsibility of being the worker's employer which reduces some of the bookkeeping and payroll issues you face as a small business.
Q: How does the IRS determine if a worker is an employee or an independent contractor?
A: The IRS employs a basic test of "control" to determine whether a worker is an employee. That is, if a business only controls or directs the worker as to the result to be accomplished and not the means and methods that are to be used in accomplishing the result, the worker is not an employee.
In real life, this test is not as easy as it sounds. The IRS has developed a list of 20 questions to help them discover which party has control - the business or the worker. A "yes" answer leads IRS to conclude that the worker is an employee, a "no" answer means that the worker is more likely an independent contractor. There is no set number of "yes" or "no" answers to the 20 questions which will determine the outcome. A business may be able to answer "no" to 12 of the 20, and yet the IRS may still determine that worker is an employee. The degree of importance given to each question varies with the particular situation.
Q: If the IRS determines that my workers are, in fact, employees and not independent contractors, am I doomed?
A: Not necessarily. Congress provided a "safe harbor" for businesses which provides that just because a worker would be classified as an employee under the common law, the worker will be deemed not to be an employee for purposes of employment taxes if certain conditions were met. Specifically, (1) the business had a reasonable basis for not treating the worker as an employee; (2) the employer did not treat the worker, or any worker in a similar position beginning after 1977, as an employee for purposes of the federal payroll taxes; and (3) for periods after 1978, the business filed all federal tax returns, including information returns such as the 1099-MISC, that are required to be filed on a basis consistent with the business' treatment of the worker not being an employee.
If these three conditions are met, the business may be granted relief. Obviously, some of the terms are subject to interpretation.