In the last article in our series on how to hire and manage employees, we discussed the advantages and disadvantages of hiring full time employees vs. independent contractors. In today’s article we are going to continue that discussion, with a look at the independent contractor requirements, and how they can lower your tax bill.
Why would you want to hire independent contractors?
- No FICA Taxes
- No Unemployment Insurance Tax
- Potentially Lower Workers Compensation Costs
- Bottom Line: Hiring people as independent contractors can save your business money!
Why wouldn’t you want to hire an independent contractor?
- In some cases where you legally cannot. The IRS provides guidelines (discussed below) for classifying workers. If you purposely misclassify employees as independent contractors, you can face fines of $1,000 to $15,000 per instance or even a criminal prosecution.
- You have to give up certain rights to control or direct the person’s work. For example, if your company has the right to tell a worker when they have to start and stop work (set hours), they are no longer are an independent contractor!
- Its morally the wrong thing to do (and will demoralize your workers). Saving money is a virtue. However, if you know a person works exclusively for you and cannot realistically pursue other opportunities, you are cheating them out of money by classifying them as an independent contractor.
What are the paperwork requirements for independent contractors?
For independent contractors that are US residents or US citizens, you will need to have to the contractor fill out a W-9 Form. Here are instructions for the W-9 form. If you pay them more than $600 per year, you’re required to issue the independent contractor a 1099-MISC by January 31st of the calendar year following when the contractor received payments. Additionally, you must submit to the IRS a copy of a 1099-MISC by February 28th (mail) / March 31st (electronic filing). Here are the 1099-MISC Filling Instructions.
For contractors outside of United States, you should establish the contractor’s foreign residency. This can be accomplished by having the contractor fill-out a W-8BEN form. Follow these instructions. Here is good article on the tax implications of hiring overseas contractors.
Independent Contractor or Employee?
There are no hard and fast rules for determining who is a contractor versus who is an employee. Or to use words directly from the IRS website:
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.
There are three general guidelines for figuring out how one should classify a worker:
- Control – How much control does the person have over how that do their job? Can the person chose when to work? Does the person have to wear a uniform or have to maintain certain appearance standards? If the person has a great deal of discretion over how they perform their work, the person is more likely to be considered an independent contractor.
- Financial Arrangement – Is the “profitability” of the job determined by the worker? Does the worker have to pay for materials, expenses, tools, extra help / hours out of their pocket? If there is no financial variability in the “profitability” of the job for the worker, he or she is more likely to be considered an employee.
- Business Relationship – Does the worker have a contract with the company? Does the worker receive benefits? An independent contractor will tend to have a contract, while an employee will tend to receive benefits.
If you hire and pay the contractor through a Freelancer site like Freelancer.com, Elance.com or Odesk you can almost always classify the person as an independant contractor.
For a more detailed explanation, see this article on the IRS website.
That’s our article for today. If you have any questions or comments please leave them in the comments section below. Also be sure to stay read the next article in this series where we discuss Where To Hire Freelancers For Any Type Of Business.
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