Posts Tagged ‘IRS’

Employers are always looking for ways to save money. Since labor is usually one of the largest single costs of running a business, if not the largest, most employers look for savings there. One of the approaches some firms take is to reclassify some or all of their people as independent contractors (ICs), and pay them on what’s called a “1099” basis. This means that instead of withholding income and payroll taxes, the employer pays them 100% of their agreed-upon rate outside the payroll, and issues them a form 1099 at year’s end, instead of a W-2.

This can generate enormous savings right off the bat – 7.65% of wages are saved due to the elimination of payroll taxes. Most companies realize additional savings because independent contractors typically do not receive any employee benefits like health insurance.

So why don’t more employers do this? Because the law is fairly clear on the difference between an employee and an IC. In addition, the penalties for misclassifying an employee as an IC are significant, and all a misclassified employee has to do to get the IRS involved is file a simple form.

Put at its most elemental, if you’re buying workers’ time – like office or factory workers, for example – you cannot call them independent contractors because they’re not independent! On the other hand, if you’re paying someone strictly to perform a specific task, like writing content for your company web page or cleaning your bathrooms, and all you’re really concerned with is the finished product delivered on time, you might be dealing with an independent contractor. Since classifying someone as an IC is done primarily to save taxes, and since the IRS takes a dim view of misclassification, let’s see what the IRS has to say about it.

The IRS looks at control as the determinant of whether a worker is an employee or an IC. There are three sets of facts to determine the level of control:

Behavioral – to what degree does the company control the worker’s activities and how the job is performed? How much autonomy can the worker exercise to get the job done? Must the worker be on-site to do the job, and must the workers report at a particular time?

Financial – who pays the bills? Is the worker paid through a payroll account? Is the work done on the employer’s premises? Who provides tools and other equipment necessary to do the job? Does the employer reimburse the worker for expenses incurred?

Type of Relationship – are there any written contracts? How about employee-type benefits like health insurance, vacation pay, or retirement benefits?

These guidelines developed by the IRS are based on the Fair Labor Standards Act (FLSA). It identifies a few additional standards, such as the length of time a workers has worked for a company, and whether or not a worker can offer the same services to other companies. I think it’s clear, though, that there’s a big difference between independent contractors and employees, and that it’s usually not a good idea to reclassify an employee as an independent contractor, no matter mow much the employer might potentially save in payroll taxes!