Definition: A person hired to do work for another but who is not an employee or
agent of that person. Control is subjected to the end result and
not as to how the work is performed as opposed to an employee who
receives direction on what, when and, to some degree, how to do a
job.
If you need additional personnel for your business but decide
your business can't afford to hire any more full-time employees,
you might consider using the services of an independent contractor.
With an independent contractor, you may save money because you
don't have to withhold and pay the person's income, Social Security
and Medicare taxes.
And while independent contractors do translate to lower payroll
costs, be advised that the IRS scrutinizes this whole area very
carefully. The IRS wants to make sure that your workers are
properly classified and paying the government the necessary income
and payroll taxes that are due.
To stay out of hot water with the IRS, be sure the workers you
classify as independent contractors meet the IRS definition of an
independent contractor. The IRS has a 20-point text its auditors
use to determine the proper classification. Here's a list of the
some of the major points:
- Who has control? A worker is an employee if
the person for whom he works has the right to direct and control
him concerning when and where to do the work. The employer need not
actually exercise control; it is sufficient that he has the right
to do so.
- Right to fire. An employee can be fired by
an employer. An independent contractor cannot be fired so long as
he or she produces a result that meets the specifications of the
contract.
- Training. An employee may be trained to
perform services in a particular manner. However, independent
contractors ordinarily use their own methods and receive no
training from the employer.
- Set hours of work. Workers for whom you set
specific hours of work are more likely to be employees. Independent
contractors, on the other hand, usually establish their own work
hours.
To stay on the right side of the IRS, it's best to document the
relationship you have with any independent contractors in a written
contract. This can be a simple agreement that spells out the duties
of the independent contractor. The agreement should state that the
independent contractor, not the employer, is responsible for
withholding any necessary taxes. In addition, have the independent
contractor submit invoices. Also, be sure you file Form 1099-MISC
(Miscellaneous Income) at year-end. By law, you're required to file
and give someone Form 1099 if you pay that person more than $600 a
year. The form must be given to the independent contractor by
January 31 of the following year. Form 1099 with its transmittal
Form 1096 must be filed with the IRS by February 28 of the
following year.
If the IRS finds you've misclassified an employee as an
independent contractor, you'll pay a percentage of income taxes
that should have been withheld on the employee's wages and be
liable for your share of the FICA and unemployment taxes, plus
penalties and interest. Even worse, if the IRS determines your
misclassification was "willful," you could owe the IRS the full
amount of income tax that should have been withheld (with an
adjustment if the employee has paid or pays part of the tax), the
full amount of both the employer's and employee's share of FICA
taxes (possibly with an offset if the employee paid self-employment
taxes), plus interest and penalties.