Independent contractors are individuals who perform work for your company but aren’t legally employees therefore aren’t entitled to many of the legal protections accorded to employees under law. There’s no federal law that clearly distinguishes employees from independent contractors, but the Internal Revenue Service has developed a set of criteria you can apply to help you ensure that you’re not inadvertently treating as contractors individuals who qualify as employees.
There are three aspects of employer control the IRS considers:
- Behavior. Independent contractors are hired to achieve certain results and are generally free to determine how those results are to be achieved. Employees by contrast are expected not only to produce a certain work product but to do so in a certain way, for example, by working certain hours at a certain place following certain established procedures. The more control employers exercise over how workers do their work, the more likely those workers are to be employees rather than contractors.
- Finances. Contractors are generally paid a set fee per project; employees are generally paid a salary or an hourly wage. Contractors generally include all expenses in the single fee they charge to complete a given project; employees often have their business expenses reimbursed by their employers over and above their salary or wages. Finally, contractors can realize a financial profit or loss from the services the perform; employees (except as their efforts are reflected in salaries or wages) cannot.
- Relationship. Contractors sell their services to the general market, work for more than one employer, and generally work for any given employer on a limited basis. Employees by contrast generally work for a single employer on a long-term basis.
To help document that independent contractors aren’t employees who have been misclassified, employers should keep copies of:
- Written contracts or work agreements that state the intent to form nonemployment relationships and prove the company couldn’t control how the contractors performed the work;
- Payment records indicating that workers were paid by the job, by the project, or by commission, rather than on a regular pay schedule, and that contractors were paid through accounts payable, not payroll;
- Records indicating that no company benefits or expense reimbursements were provided to independent contractors;
- Evidence that the contractors did similar work for other businesses while they were working for the company; and
- Evidence that the contractors advertised their services to the general public.
Paying independent contractors
If a worker qualifies as an independent contractor under IRS rules, it’s best to pay that worker through accounts payable, rather than through payroll, to avoid any appearance of an employment relationship. And you should not withhold federal or state income taxes, withhold or pay FICA (Social Security and Medicare) taxes, or pay FUTA (federal unemployment) tax on an independent contractor’s earnings. Independent contractors are responsible for paying their own federal income, Social Security and Medicare taxes to the Internal Revenue Service. As self-employed workers, independent contractors pay a tax equal to both the employer’s and the employee’s share of Social Security (12.4%) and Medicare (2.9%).
Don’t allow independent contractors to furnish you with a Form W-4, Employee’s Withholding Allowance Certificate, as they’re not your employees and you won’t be withholding any tax. Maintaining a W-4 on an independent, even for informational purposes, is another indicator that you have an employment relationship. Instead, ask them to complete IRS Form W-9 so you will have their Taxpayer Identification Number (often the worker’s Social Security number) and address for your records. This information is critical because, if you pay an independent contractor $600 or more during the year, you must report all payments to that worker on IRS Form 1099-MISC.