By Andy Roe
Independent contractors have become an important part of many small business operations. According to data from our customers, about 6 percent of their staffs are made up of independent contractors.
For a small business with limited resources, it’s not always possible or necessary to hire a full-time employee, depending on the task. So it’s become common for a small business to outsource functions like marketing, design and copywriting, just like they have for years with legal and accounting work.
Using independent contractors often seems like a practical way to get things done at a reasonable cost, because you’re generally not required to pay for things like fringe benefits and payroll taxes.
However, from a payroll perspective, when treating a worker as an independent contractor, it is important to understand that there are specific details you must pay attention to along the way.
An independent contractor is not the same as an employee. The IRS discusses both classifications in great detail, so be sure to reference this page if you are having trouble differentiating between the two.
When considering using an independent contractor, it is time to set your sights on these three details:
1. Taxes. You are not responsible for withholding taxes on behalf of an independent contractor. However, you are responsible for issuing a Form 1099-MISC to any worker who you paid more than $600 in the year.
Note: You will send a copy of the form to both the contractor as well as the IRS. Doing so will entitle you to a deduction.
2. Differences from Employee Classification. There are advantages associated with paying for the services of an independent contractor, as opposed to hiring an employee. For example, the company generally doesn’t have to offer and/or pay for fringe benefits or withhold taxes for a bona fide independent contractor. Independent contractors are also not subject to minimum wage and overtime laws.
The IRS and the Department of Labor are well aware of these advantages and both agencies have been active in their enforcement efforts around misclassification of workers. Subsequently, companies that use independent contractors may have an increased chance for a tax or wage and hour audit.
It is important to be 100 percent sure that a worker is correctly classified as an independent contractor. If you make a mistake here, it could cost you big time in the event of an IRS audit or an audit from the Department of Labor.
Generally speaking, if a company controls how and when a worker performs his work for the company and the worker is expected to follow the same rules as employees – such as a certain time when he or she must visit the office – it is likely the worker would be considered an employee.
On the flipside, here are some factors that may mean the worker would be considered an independent contractor:
- Offers a specialized skill
- Works on a project basis
- Has more than one client
3. Contract. If you decide to pay for the services of an independent contractor, consider a written agreement. This should be signed by both the company as well as the contractor. The contract is neither a requirement or always recommended. It depends on the relationship of the parties. A poorly written contract can result in far more issues than misclassification.
Tip: It is best to consult with a labor and employment attorney to draft your independent contractor agreement. This will help ensure that all necessary language is included.
Using independent contractors may sound like a confusing and complex process. There are many details to consider, such as the three detailed above, but it may still be the right decision for your company. .
Andy Roe is the General Manager of SurePayroll, Inc., a Paychex Company. SurePayroll is the trusted provider of easy online payroll services to small businesses nationwide. SurePayroll compiles data from small businesses nationwide through its Small Business Scorecard optimism survey, and exclusively reflects the trends affecting the nation’s “micro businesses” — those with1-10 employees. You can follow Andy on Twitter @AndrewSRoe.