Whenever you decide it is time to grow your workforce in your business, you have a number of things to consider. One of the first choices you need to make is whether you are hiring an independent contractor or an employee. To begin, let’s look at the high level distinctions between the two:
- Independent Contractors – They are independent workers that tend to dictate when and how they work. They often use their own equipment and must cover their own expenses. Typically this is a worker that could run a small business performing the work they perform for you for multiple companies.
- Employee – These are workers who are told when and where to come to work and they must perform certain tasks in a certain manner. They often have benefits and work in your office. Payroll taxes are required of employees.
The distinction is important not only because of the cost-savings associated with independent contractors, but also because you need to know how to properly treat your worker. Treating a worker as an employee, but paying them as an independent contractor can lead to some serious consequences down the road for your business.
There are a couple of different ways to approach the decision. You can either decide what you think you want and make sure the relationship looks correct, or you can look at the relationship you plan to have (or currently have) with your workers and determine where it fits.
Either way, you need to consider the various elements of each type of relationship. Today, let’s look at the Independent Contractor Relationship.
Independent Contractors are such a great way to help a business scale the way it needs to. The independent contractor relationship can help a young company find some of the best talent at the lowest possible cost. It can also allow a business to use talented people for the time when it needs them, without complicated employment laws and taxes lowering the money they can offer the worker who deserves it.
The IRS has decided to start cracking down on small businesses use of Independent Contractors. In many cases, this is a good thing. The system has been abused for some time. For some businesses, however, the “twenty factor” test was just too difficult and unclear that drawing any clear guidance on how to treat a worker was almost impossible.
I must give credit where credit is due. The IRS did change the “twenty factor test” to eleven. They even tried to “help you out” by organizing the eleven factors into three main groups. Though, they still will not explain the weight given to each factor. I have translated the factors below. For the translation, I will use the word “worker” because this test determines if the “worker” is an independent contractor or employee.
1. What you tell the contractor about how, when, where, or with whom to work.
2. How you train the worker.
3. The reimbursement policy with the worker.
4. What kind of investment the worker has in the work.
5. Whether the worker’s services are available to others.
6. How the worker is paid.
7. Whether the worker can make a profit or a loss (as opposed to just a salary).
Type of Relationship
8. What the written agreement says about the intended relationship.
9. Whether the employee receives benefits from the employer.
10. The permanence of the worker in the business.
11. Whether the worker’s services are a key aspect of the company’s regular business.
So, What Does that Mean for Your Business?
It means, you need to clarify the roles of work in your business. It means, your contracts need to outline how the relationship is to work. Independent Contractors must be independent. Some independent contractors are easy to spot:
- Other Businesses
Though each of those relationships should be in writing, it is when your business brings on an individual to perform a service for your business that you need to make sure you have all of your ducks in a row when it comes to your independent contractor agreement.
Step One: Get it in writing
Especially for Independent Contractor relationships, you need to make sure the relationship is documented. It is even one of the factors! Even though the IRS says the contract is probably the least important of the factors, it can help. It shows your intentions. It helps even more if your agreement establishes that the relationship with the worker meets the guidelines in word as well as in deed. Make sure your independent contractor agreements show establish a relationship with an independent worker.
How do you show the worker is independent?
You incentivize their work. You require them to bring their own device. You do not tell them when to be at your office. You do not pay their benefits. You do not pay their taxes. You treat them as if they own their own business. You encourage them to start their own business to provide the services you need. You don’t call them an employee (this is a big one).
Let Your Worker Be Independent.
This is not terrible advice for employees. If you give them ownership in their work, you will see better results. But, this is necessary to save yourself the headache and expense of giving the IRS the good pleasure of proving you have been paying an employee as an independent contractor. If they do that, you owe back payroll taxes.
That. Is. Not. Fun.
So, take my advice and treat your worker as independent.
Do you use independent contractors in your business? How do you make sure your worker’s are, in fact, independent contractors?
I will talk to you next week,