Hiring an employee or an independent contractor isn’t as simple as you’d think. In fact, there are real world implications for misclassifying a worker as an independent contractor, including liability for employment taxes, unpaid wages, insurance claims, violations of labor laws, and even lawsuits.
It's crucial to understand how the IRS and labor authorities expect you to classify your workers. In basic terms, there are three measurement criteria – behavioral, financial, and the type of relationship you have with a worker.
That said, hiring independent contractors can be essential to your business, and you wouldn’t want to miss out on that. So how can you know? Here’s what a CPA wants you to know before you start the hiring process.
We’re only kidding, of course. But we do use the phrase, “If it looks like a duck, walks like a duck, and quacks like a duck – it’s a duck.” So how does that present itself with regard to hiring an employee vs an independent contractor. Well, if your worker is doing scheduled, regular work for you – the IRS will probably deem them an employee.
On the other hand, if your hire is an independent contractor, they shouldn’t be working for you on an hourly basis; they’ll be paid for deliverables, and they won’t have the same relationship with you as they’d have as an employee. Let’s get more detailed in what we mean by this.
The IRS actually has some really great guidance about this very topic. For them behavioral control boils down to four ideas.
Basically, the more instruction you give them, the more likely they are to be designated as an employee. That can refer to their day-to-day work, instructions on specific projects, or even their training. Here’s what the IRS has to say:
“If the business provides the worker with training on how to do the job, this indicates that the business wants the job done in a particular way. This is strong evidence that the worker is an employee. Periodic or ongoing training about procedures and methods is even stronger evidence of an employer-employee relationship. However, independent contractors ordinarily use their own methods.”
If you have a specific task that the potential hire is already trained for and can handle without any of your direction, then you can likely designate them as an independent contractor. Take, for example, a CPA who has special training in a specific form that our customers need. They may work as an independent contractor, since their training, methods, and ultimate execution are done without your guidance as an owner.
The simplest idea of this is the 1099. If you issue them one, they’re officially designated as an independent contractor. That means that they’ll have to take out their own taxes, and report those earnings themselves at the end of the year. That said, there are other ways in which financial control can be important. According to the IRS those are:
If the hire is spending significant amounts on unreimbursed expenses, it’s more likely they are an independent contractor than an employee. Additionally, independent contractors aren’t chained to a particular business – they’re allowed to and should seek out other opportunities, advertise, and even maintain a business location. If they only work for you, it is much more likely that they are an employee.
Oftentimes, written contracts will come up when discerning this relationship. Here’s the thing: while a contract may state your worker is an employee or an independent contractor, that isn’t always enough to determine the worker's status. It’s more important to look at how both parties work together to determine whether that worker is an independent contractor or not. To do that the IRS may look at
If you're providing a worker with insurance, pension, vacation or disability insurance, they’re very likely (though not always) an employee. Similarly, if you hire a worker with the idea that they will continue to work for you indefinitely – rather than for a specific project or period of time – then that’s usually a good sign that they are an employee. And if their responsibilities include “key activities” of the business, that, too, would be a sign the worker is an employee.
Sometimes these ideas aren’t as straightforward as we’d like them to be. In that case, we recommend you talk to an expert. Consulting with your CPA is a critical part of making sure that you don’t get in trouble with the IRS or labor offices. Make sure that you’re covered! Ask an expert.