Avoid IRS Ire by Following Rules on Contract Workers
I was catching up with my bookkeeper last week when she told a story that scared me. Another client of hers had recently been audited and paid a hefty fine due to shoddy documentation relating to her business’s independent contractors. The client hadn’t had contracts in place with these independent contractors to document their status.
A review of how my business handles independent contractors assured me that we have a good system in place, but the story is a wakeup call for all businesses to review current practices.
Over the years I’ve worked with a lot of freelancers. I’ve hired writers for direct mail pieces, Web designers to build my company’s site and specialists to arrange speaking engagements for staff members. Everyone has fallen under the title of independent contractor because, among other things, they serve multiple clients, decide how to complete projects and work from their offices.
Independent contractors are the best solution when you need a specialist for a short-term assignment. These jobs are often difficult to staff in-house because your business might not need a full-time person for the job and the best talent often works freelance. Writers and graphic artists are great examples because most businesses need them intermittently, and many of the best professionals do not want full-time jobs.
When the Internal Revenue Service determines how a worker should be classified, the issue of how much control an employer has over a worker is critical. Here are some factors the IRS evaluates when it decides if a worker is an employee or independent contractor. Visit the IRS Web site address listed at the end of this column for complete details and use these tips as general guidelines.
– How is the work structured? Independent contractors are best suited to short-term projects. The IRS may view contractors who work on recurring projects as employees.
– Whose equipment will be used? Independent contractors are likely to own the tools necessary to complete jobs related to their specialty.
– Where will the work be done? If a worker has to be at your office to complete a project successfully, your relationship may be considered employee-employer.
– Who hires, supervises and trains assistants? If contractors need help with a project, they should use their own resources, rather than rely on your staff members.
– Who do they work for? True independent contractors often seek out and perform work for other clients. Many also maintain a visible business location.
– Do they have business cards? Contractors often advertise their services to get new clients. For this reason, simply having an independent business card can raise a contractor’s credibility in the eyes of the IRS.
– Are they incorporated? While being incorporated does not prevent contractors from acting as staff members, it does suggest that they run their professional lives independently from the businesses for which they work.
If you regularly work with independent contractors, write up a contract at the beginning of each project. This is one way to protect yourself from IRS claims that you have misclassified a worker as an independent contractor. This document should spell out that the worker is an independent contractor and should address the items above, such as where work will be completed, how much the contractor will be paid and whose equipment will be used.
One word of caution: This written agreement will not hold up as a defense with the IRS if a worker in question is clearly an employee. It can, however, make the difference in borderline situations. If you need the IRS’s help with determining whether a worker is an employee or a contractor, visit the IRS Web site at www.irs.gov.
Alice Bredin is author of the “Virtual Office Survival Handbook” (John Wiley & Sons) and a nationally syndicated columnist.
