Peter G. Robbins, CPA, The Daily Record Newswire
Q: Over the next few months our company is going to need some extra help. This is only a temporary situation, so we don’t want to hire a new regular employee and go through the process of offering benefits, direct deposit of payroll, et cetera. But we have heard the Internal Revenue Service often has issues with using independent contractors. Since this will only be a temporary position, can we just pay someone an hourly rate without treating him as an employee?
A: You are correct that over the past years there has been quite a bit of controversy over employee versus independent contactor status. A complete analysis of a particular worker’s classification is specific to your situation, and I recommend you consult with a professional to make sure you will pass IRS scrutiny. But hopefully I can offer some general guidance on this issue.
The determination of whether an individual is an employee or an independent contractor governs how the employee is paid and taxed, and how the payments to the worker are reported at the end the year. If the worker is considered an employee, the employer must withhold federal and Idaho income, Social Security and Medicare taxes, and pay all federal and Idaho unemployment taxes. The employer is required to issue a Form W-2 to the employee reporting all the wages and taxes, and the employee will need to be covered under any benefit plans the employer offers.
As an independent contractor, no taxes are withheld from payments made to the worker. The individual is given a Form 1099-MISC reporting all the payments received, and the contractor uses this information to prepare his or her tax return. The independent contractor is responsible for paying all the income taxes as well as 100 percent of the self-employed Social Security taxes.
There is a key economic difference between employee versus independent contractor status. The employer must pay half of the Social Security taxes if the worker is an employee. If he is an independent contractor, the worker pays all. The IRS is alert for employees erroneously categorized by a business as independent contractors, because they can assess significant penalties for delinquent payroll taxes on the business.
The IRS generally looks at the facts and circumstances surrounding the relationship between workers and employers, and these considerations fall into three broad categories: behavior control, financial control and relationship of the parties. You can, in fact, request a formal determination from the IRS by filing Form SS-8, but most of the time good judgment will be sufficient. Here are a few key items to consider:
Behavior Control
The more employer control over the way the work is done, the more the classification indicates the worker is an employee. The worker will most likely be considered an employee if the employer controls how, when or where the work is performed; provides the tools and equipment used by the worker; designates other individuals who will assist in the work performed; and controls when and where supplies and outside services are purchased. Also, the more training the company provides for the worker, the more likely the worker is an employee. To the extent the employer exercises control over one of these items, but not another, the employee/independent contractor distinction gets blurred and more judgment is involved.
Financial Control
If the worker has a financial commitment in the work being performed, the scales tip toward being an independent contractor. So independent contractor status is more likely if the worker provides his or her own tools and equipment, has incurred the costs of necessary training, or is responsible for any business expenses incurred. Further, having the opportunity to control profit or loss derived from the work activity indicates independent contractor status; no risk of loss indicates employee status.
Relationship of the Parties
The manner in which both the worker and the employer arrange their relationship is also important. If the employer offers benefits such as paid time off and health insurance, the IRS will likely consider the worker an employee. But not offering these benefits may not guarantee independent contractor status. Also, the worker’s ability to perform work for another employer can be a factor favoring classification as a contractor. Finally, a written contract between the worker and the employer clearly stating the intention of the parties and the way in which the employer represents the worker to customers and the public are factors to consider.
Obviously the designation is important, but unfortunately it is often quite subjective. But take heart! There is another option you might consider. Rather than hiring the worker directly, you might consider engaging one of Idaho’s many temporary employment agencies to provide the help you need. Since you are hiring the agency, not the individual worker, there is no question regarding the worker’s status. If you are looking for short-term help, this might be your best option.
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To ensure compliance imposed by IRS Circular 230, any U.S. federal tax advice contained in this article is not intended or written to be used, and cannot be used by any taxpayer, for the purpose of avoiding penalties that may be imposed by governmental tax authorities. The answers in this column are meant to offer general information. You should consult your tax adviser regarding the specifics of your situation.
Peter Robbins is a partner in the Boise, Idaho, office of CliftonLarsonAllen, LLP specializing in tax matters for small businesses, individuals, and trusts and estates.
