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Does my small business have employees or independent contractors

Written by: Allan Branch

Article Overview: Make sure you are doing business right when working with other people.Do you have employees or contractors. Do YOU really know the difference?

Does my small business have employees or independent contractors

This article was written by our accountant. Who is the best accountant anywhere. We strongly recommend that every small business owner invest the time to find an accountant that will save you money.

During the life of most small businesses, every owner might need help producing the deliverables and enlist persons outside their immediate family for help. Now the decision of how the helpers will be paid must be made. Should they be paid as an independent contractor or withhold taxes from their compensation as an employee? The biggest determining factors should not be what are easiest for the owner but rather what are correct in the eyes of the Internal Revenue Service.

In the past decade, the IRS has developed guidelines and common law rules to help small business owners make the right choice between independent contractor and employee. The decision should be well thought out and well documented in case of possible disputes later from either the helpers or the IRS. The trend has been for the IRS to view all helpers under the direct control of a business owner as their employees not as contractors. This view allows for an easier method of tax collections direct from a single business owner rather than chasing down several independent contractors.

So, be careful with your choice, if the helpers you paid as independent contractors are determined later by the IRS as employees then the Trust Fund recovery penalty which is federal income tax, social security and Medicare taxes not withheld will be assessed to the owner.

Below are excerpts direct from the irs.gov web site and might help you make the correct choice.

The general rule is that an individual is an independent contractor if you, the person for whom the services are performed, have the right to control or direct only the result of the work and not the means and methods of accomplishing the result.

Example: Vera Elm, an electrician, submitted a job estimate to a housing complex for electrical work at $16 per hour for 400 hours. She is to receive $1,280 every 2 weeks for the next 10 weeks. This is not considered payment by the hour. Even if she works more or less than 400 hours to complete the work, Vera Elm will receive $6,400. She also performs additional electrical installations under contracts with other companies that she obtained through advertisements. Vera is an independent contractor.

Common Law Rules

Facts that provide evidence of the degree of control and independence fall into three categories:

1.

Behavioral: Does the company control or have the right to control what the worker does and how the worker does his or her job?
2.

Financial: Are the business aspects of the worker’s job controlled by the payer? (these include things like how worker is paid, whether expenses are reimbursed, who provides tools/supplies, etc.)
3.

a class="western" href="http://www.irs.gov/businesses/small/article/0,,id=179116,00.html">Type of Relationship: Are there written contracts or employee type benefits (i.e. pension plan, insurance, vacation pay, etc.)? Will the relationship continue and is the work performed a key aspect of the business?

Businesses must weigh all these factors when determining whether a worker is an employee or independent contractor. Some factors may indicate that the worker is an employee, while other factors indicate that the worker is an independent contractor. There is no “magic” or set number of factors that “makes” the worker an employee or an independent contractor, and no one factor stands alone in making this determination. Also, factors which are relevant in one situation may not be relevant in another.

The keys are to look at the entire relationship, consider the degree or extent of the right to direct and control, and finally, to document each of the factors used in coming up with the determination.

Finally, remember to ask a Certified Public Accountant or tax professional before making a final decision because as the owner the ultimate liability always falls directly on you.

Related Articles
  Who is Considered an Independent Contractor
  Employees vs. Contractors - What's The Difference?
  Contract work: the pros and cons.
  Small businesses turning to contractors
  Errors in Job Placement: the Four Categories of Employment

Article Tags: accountant, common law, correct choice, deliverables, electrical work, electrician, federal income tax, gov web, immediate family, independent contractor, independent contractors, internal revenue service, irs gov, right choice, small business owner, small business owners, small businesses, social security and medicare, tax collections, trust fund



Related Forum Posts
Template of Service Agreement/Contractor Agreement - Just wondering if anyone has some good templates of a service agreement between a company and any contract-type workers. So it would be different from an employee offer letter. I am hiring a new instructor for my school and would like to have something in writing even though they are not actually hired as employees, more like independent contractors. Thanks!
Re: Template of Service Agreement/Contractor Agreement - [quote="Dave_Adler":21fe7egl]Shimmy- I, too, would be happy to share my template contract for a service provider. But beware, a template agreement may not be sufficient to properly address your needs. Some key differences between Employees and Service Providers: 1. Tax Status. Employers are responsible for withholding tax on employee's earnings. Independent Contractors are responsible for reporting their income/taxes. There is a significant reporting burden and liability associated with this. 2. Confidentiality/Intellectual Property. Often times, employee handbooks will specify an employees confidentiality obligations and many states impute a duty of loyalty. Contractors are under no such obligations absent a written agreement. Same thing for IP/Creative works. The copyright Act draws a sharp and significant distinction between employees and contractors when it comes to ownership of creative works. 3. Liability for tortious acts. Generally an employer is liable for the tortious acts of its employees under the theory of respondeat superior. An entity hiring a contractor may/may not be liable, but without a written agreement for the contractor to indemnify/defend the hiring entity, their may be little recourse against the contractor. There are many other subtle differences too numerous to mention. I hope you find this helpful.[/quote:21fe7egl] I was thinking these same points as I was reading the earlier posts. I've been working with independent contractors for years - first as one, and then hiring many of others. These are three of the key things to be sure you include in your agreement. If they are truly an independent contractor, they are reasonable to handle their own taxes. I always include a confidentiality clause and very few have tried to break it. Liability can be a huge issue, depending on the sort of business you are in. In the US - there are all sorts of tax rules for state and federal government to distinguish if a person is or is not an independent contractor. If you make the wrong choice there are all kinds of penalties to be paid. Another thing that should be considered is that your business worker's compensation and/or liability insurance may have to cover these people. I know in construction, I'm charged for any independent contractor and their employees if they don't have their own insurance. That can get really pricey. If you're in a similar situation, talk with your insurance company, some will allow an independent contractor to sign an agreement that they will waive your responsibility to insure them. You would still need to pay for their employees, but it does save some money during an insurance audit. Chris
employees or 1099? - In my line of work, we are trying to keep our costs down and stay as "virtual" as possible. I was wondering if anyone had some insight as to whether I should hire employees or contractors? My apologies, here is a description of the situation so you might actually be able to answer my question. Little Man Consulting has a policy to NOT meet with clients unless they are truly against the completely virtual environment. As my company has quadropled in size this year alone, I am finding it harder and harder to keep up with the work and still grow the business. There are other Virtual Assistants out there. Should I farm out the work, or bring in employees?
Re: Keeping Employees Happy - [quote="MM571":3u44n45r]1. Instead of hiring consultants to train employees, cater lunch once a month and rotate employees teaching co-workers what they know best. [/quote:3u44n45r] This has been very effective for me. The guys who work with me are all consultant/contractors by choice, but I'll frequently pay for day of consulting time to have them cross-train each other. It's been a win-win for everyone involved so far. - For me, it makes the business stronger from the added depth on the bench and brought the added bonus of loyalty from these guys. - For them, their skill sets have gotten broader and they are picking up more opportunities (not just from me).
Re: Should you hire ambitious workers or employees with no goals - Hiring employees in a small business is more a matter of personal fit than an absolute standard. If the business owner is a hands-on, controlling character, hiring people who follow orders precisely may be the way to go, but if the owner is a freely delegating, open to new ideas kind of person, ambitious employees will suit better. Personally, I've always hired the latter. In any situation, I wanted to be able to grow my employees and the entire system, so that I can grow myself. Having employees who require continual supervision means my capacity to manage them will be maxed out at some stage and development will stop. I guess someone who sees himself as a business owner may hire people who can carry out a specific function and no more, while an entrepreneur will hire people who can "grab the ball and run with it", so that he can move on to the next initiative, while the current business ambitiously runs itself. What a great discussion!


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