Independent Contractors

Sherrie Bennett

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Are you undecided about hiring independent contractors to do your business? It can be a profitable experience as long as you think ahead.

An independent contractor is basically someone who is in business for themselves and - more importantly - isn't your employee.

Pros

• Your business can save money, because you won't have to pay for the independent contractor's federal payroll taxes, social security, unemployment insurance workers' comp health insurance, vacations and sick leave.
• You also won't have to rent space and pay for office furniture for the independent contractor.
• An independent contractor can't sue you for discrimination or being fired.
• You don't have to train an independent contractor, and they can usually start productive work right away.

Cons

• Independent contractors can sue you if they're injured on the job due to your negligence, because they aren't covered by workers' comp.
• If you later find out that someone you thought was an independent contractor is really considered an employee, you may have to pay back taxes and penalties (up to 35%).

Employee Versus Independent Contractor

Different governmental agencies use different tests for deciding when someone is an independent contractor versus an employee.

Internal Revenue Service

Of most concern is the IRS, which has developed a 20-factor test for determining whether someone is an employee for whom you must pay payroll taxes:

Do you have the right to control how the worker does the work?

• Do you give the worker extensive instructions on how, when or where to do the work?
• Do you provide the worker with training about procedures and methods?
• Do you set the working hours of the worker?

Do you have financial control over the worker?

• Do you reimburse the worker for business expenses?
• Do you absorb the profit or loss from the worker's performance?

How do you and the worker see your relationship?

• Does the worker receive benefits, like health insurance or a retirement plan?
• Do you have a written employment contract which allows you to fire the worker?
• Does the worker have a continuing relationship with your business?
• Is the worker paid by the hour?

The presence of these factors makes it more likely that the IRS will consider the worker an employee rather than an independent contractor for tax purposes.

State Agency Tests

State laws vary as to when a worker is considered an employee versus an independent contractor for unemployment compensation, workers' comp and state tax purposes.

Some state agencies use what's called an economic reality test that focuses on how economically dependent the worker is on the hiring business.

In many states, unemployment compensation laws follow what's called the ABC test, which focuses on:

• Whether the worker is operating a business independent of the hiring business.
• Where the work is actually performed (onsite at the hiring business or elsewhere).
• What control the hiring business has over the worker while the job is being performed.

When You Want to Hire an Independent Contractor

To make sure you're actually hiring an independent contractor:

• Find out ahead of time how your state's unemployment compensation, workers' comp and state tax agencies determine who is an independent contractor.
• Have the prospective worker fill out an "independent contractor form" rather than a job application. This should include information such as the name, address and phone number of the independent business, number of employees, professional and business credentials of the business, names of other businesses the worker's company does business with and the worker's business insurance.
• Ask the prospective worker to provide you with documenting evidence for business credentials and insurance, such as articles of incorporation and insurance policies.
• Get a signed independent contractor contract with the worker, which sets out the specifics of the relationship, including where the work will be performed, how the worker will be paid and the fact that the worker is responsible for paying his or her own federal and state taxes, social security and other expenses. The contract should make it clear that your business owns the work product of the worker for all purposes.

Sherrie Bennett is the former director and staff attorney at the University of Washington Student Legal Services in Seattle.

Related Web Links:

IRS Employee - Independent Contractor

Employment Law For Employers Message Board for more help