Apparently the IRS has something to say about this… and they want to make sure you’re listening. The IRS has just released a template for individuals to use in order to determine, for themselves, if they have been classified correctly as either an employee or independent contractor.
So why is the IRS so concerned about this? Well from an employer stand point, paying others as independent contractors has it’s benefits – the biggest being that it will save the employer money, lot’s of it.
How will an employer save money using independent contractors? First off, they’ll pay less in taxes and fees because they don’t have to pay payroll taxes, Social Security, Medicare or Federal or State Unemployment Tax. On average, expect to save about 8% by using independent contractors.
Second of all, from a benefits standpoint, most benefit plans require that employers cover all employees, not independent contractors. As you can probably see, the incentive is pretty strong for employers to convert all employees to independent contractors.
But wait, before you send out that memo letting everyone know they’re now independently employed, keep the following in mind:
The IRS Wants You To Have Employees.
Why? You’ll pay more in taxes of course. About 60% of all taxes collected by the IRS come by way of employment taxes. For every independent contractor you hire means less tax revenue for the government.
From the IRS standpoint, determining who is a true independent contractor and who is really an employee involves more then simply labeling them as such. This is why they’ve recently released some tools to help define who is truly an employee and who is actually an independent contractor.
It basically comes down to three areas you must ask yourself:
- Behavioral Control
- Financial Control
- Relationship of the Party
After going through each of the questions for each area, the IRS claims that it should be pretty clear whether or not you’re really an employee. More information on each of the areas can be found below.
A worker is an employee when the business has the right to direct and control the worker. The business does not have to actually direct or control the way the work is done — as long as the employer has the right to direct and control the work.
- Receiving Instructions: If you receive extensive instructions on how work is to be done, this suggests you are an employee. Instructions can cover a wide range of topics, such as:
- How, when, or where to do the work
- What tools or equipment to use
- What assitants to hire to help with the work; and
- Where to purchase supplies and services
If you receive less extensive instructions about what should be done, but not how it should be done, you may be an independent contractor. For instance, instructions about time and place may be less important than directions on how the work is performed.
- Training: If the business provides you with training about required procedures and methods, this indicates that the business wants the work done in a certain way.
These facts show whether there is a right to direct or control the business part of the work. Consider:
- Significant Investment: If you have a significant investment in your work, you may be an independent contractor. While there is no precise dollar test, the investment must have substance. However, a significant investment is not necessary to be an independent contractor.
- Expenses: If you are not reimbursed for some or all business expenses, then you may be an independent contractor, especially if your unreimbursed business expenses are high.
- Opportunity for Profit or Loss: If you can realize a profit or incur a loss, this suggests that you are in business for yourself and that you may be an independent contractor.
Relationship of Parties
These facts illustrate how the business and the worker their relationship. For example:
- Employee Benefits: If you receive benefits, such as insurance, pension, or paid leave, this is an indication that you may be an employee. If you do not receive benefits, however, you could be either an employee or an independent contractor.
- Written Contracts: A written contract may show what both you and the business intend. This may be very significant if it is difficult, if not impossible, to determine status based on other facts.
Having independent contractors will save you money, but you MUST do it right. That means following the new IRS rules as well as having a signed Independent Contractor Agreement.
You may pay less in taxes, but you also don’t want to invite trouble by incorrectly labeling an employee as an independent contractor.