Independent Contractors or Employees.
There are a variety of reasons why businesses choose to characterize their work force as independent contractors, rather than employees, from trade or industry practice to budget flexibility. Regardless of the reasons, the practice is heavily scrutinized and has devastating consequences for the payer if workers are incorrectly characterized. In addition, the IRS recently moved the deadlines for sending certain 1099s up to January 31st.
The rules generally place responsibility on the paying business to properly characterize each service provider as an independent contractor or employee. Some are easy, such as outside lawyers and accountants. Others are more difficult, like construction workers. The lines get blurry the closer the work preformed for the payer is closer to its core business, and the question of whether the worker is an independent contractor or employee is determined by the underlying facts. Herein lies the issue – incorrectly characterizing a worker as an independent contractor can be financially expensive. The IRS and various federal, state and local employment agencies will look to the paying business to recover back income taxes or withholding and unpaid employment taxes, together with penalties and interest and the IRS can request the payer apply a 28% backup withholding tax from a worker’s future payments. Not to mention liability and employee benefits issues that may arise and the accounting and legal expenses paid to resolve the issues. Needless to say, business owners should educate themselves on the rules and implement procedures to reduce or eliminate any exposure.
The IRS and various federal, state and local agencies frequently refer to certain common factors in determining independent contractor status. These factors are grouped into three categories – behavioral (who controls the worker and his assistants), financial (is there an opportunity for profit or loss), and type of relationship (what is the understanding of the parties). No one category or factor controls the decision, so businesses must look to the entirety of the circumstances. Details on the factors and other IRS information can be found at https://www.irs.gov/businesses/small-businesses-self-employed/independent-contractor-self-employed-or-employee.
In addition to reviewing the IRS’s factors indicating an employment relationship and avoiding them, the best practices for businesses that use independent contractors is to make sure (1) each worker is operating under a properly formed corporation or LLC using a name other than their personal name, (2) the payer has a signed independent contractor agreement with the worker outlining the terms and conditions of the arrangement between the parties, and (3) the paying business obtains a properly completed W-9, codes the contractor as eligible for an IRS Form 1099 in its accounting software, mails the 1099s for non-employee compensation before January 31st (other deadlines may apply under certain circumstances) and files IRS Form 1096 with the IRS. Conforming with these basic principles will reduce the chance of an issue arising and allow you to stay focused on growing your business.
If you would like DeAngelis Legal to review your workforce facts to determine whether the workers should be characterized as independent contractors or employees or create an independent contractor agreement tailored to your business and relationships, just give us a call.