SMALL BUSINESS ADVISORY SERVICES
Question:
Employee vs Independent Contractor.
Answer:
Basically, a worker’s job responsibilities and the level of control you exert over how the worker performs that job are the primary considerations in determining a worker’s proper classification as an employee or independent contractor (1099). All jobs and workers do not qualify for independent contractor classification. If you are uncertain about the proper classification of the workers you plan to engage for your business, you should review the details of their responsibilities with your business lawyer to assure that you handle their compensation, payroll taxes, and insurance in accordance with labor and tax regulations. As a LegalShield (LS) business plan member, you can contact your LS Provider Lawyer for advice and assistance, or referral to a local labor lawyer if necessary, at the phone and fax numbers included in your LS materials or phone LS Customer Service at 800-654-7757. For discussion with your lawyer and to help understand the differences between worker classifications, the following is information on the considerations when engaging workers as independent contractors.
1. Independent contractor classification considerations. Independent contractors pay their own payroll taxes and insurances, including workers’ compensation and bonds, and are not covered by many labor laws, so the financial and administrative benefits of having a workforce composed of independent contractors can be significant. However, it is crucial for business owners to understand that independent contractor status is not an arbitrary election but is based on the job structure and level of control the party who engages the worker exerts over how the worker performs that job. It is also important to understand that independent contractor status cannot be established or supported by the completion of any particular forms or tax paperwork (like Form 1099-MISC), the registration of a DBA, the drafting of a carefully worded offer letter or an independent contractor agreement, piece work, commission, or other performance-based compensation method, or by part-time, project based, seasonal or other short-term work arrangements.
Misclassifying workers as contractors can have labor law, employee benefits, employment tax, and workers’ compensation implications for businesses and the affected workers. For example, making the wrong determination of a worker’s status can result in IRS and state tax audits with back tax assessments that can be ruinous to a small business; therefore, it is important that a business owner understand the criteria that the IRS and state authorities use in determining whether a worker is properly classified as an employee or an independent contractor. To develop a better understanding of the risks, you can review discussions on the topic at websites like the following:
http://www.inc.com/articles/2000/11/21663.html
http://www.lexology.com/library/detail.aspx?g=adf2d958-55cd-4b28-901b-11d5ced569e7
https://www.dol.gov/whd/workers/misclassification/
Whether a particular worker qualifies as an independent contractor with regard to the services provided your business will depend on all the facts and circumstances. An independent contractor is a legal category of worker defined by the Internal Revenue Service. The basic difference between an independent contractor and an employee under the IRS definition is that, unlike employees, independent contractors retain control over how the work they are hired to do gets done; the person or company paying the independent contractor controls only the outcome – the product or service. With an employee, by contrast, the person or company paying an employee controls not only the outcome of the employee’s work, but also how the work they do gets done. In order to determine whether a worker qualifies as an independent contractor rather than an employee, the worker’s job and the control you exert over the worker must be evaluated under what is known as the common law right of control test. Under this subjective test, for which the IRS developed a 20-factor analysis for its auditors, the IRS basically takes the position that if you tell a worker what to do and how to do it, then that worker is an employee. To add to the classification difficulty, state government agencies often use different criteria than the IRS for classifying workers as employees or independent contractors for state tax and workers’ compensation purposes and some states can impose severe penalties under state law on businesses that misclassify workers as independent contractors. Since the potential penalties for misclassifying a worker as a contractor rather than an employee can be severe, you should clarify with your business lawyer that a worker’s job meets the IRS criteria for independent contractor status before engaging the worker.
You can review the IRS criteria for determining whether your workers are properly classified as independent contractors at the website below. If you are uncertain about the proper classification of your workers, you should review the details of their responsibilities with your lawyer to assure that you handle the compensation, payroll taxes, and insurance in accordance with labor and tax regulations. You can review government and general discussions about independent contractors and hiring workers at the following websites:
http://www.nolo.com/legal-encyclopedia/contractors-freelancers/
You can also review more in depth discussions at the following IRS websites:
http://www.irs.gov/pub/irs-pdf/p15a.pdf (see 2. Employee or Independent Contractor?)
You can review California independent contractor information at the websites below, the first of which explains…
“California Test for Employment
To determine if a worker is an independent contractor or an employee, look at the main test and the ten secondary factors.
Main Test
Does the principal (you) have the right to control the manner and means in which the worker carries out the job? The right of direction and control, whether or not exercised, is the most important factor in determining an employment relationship. The right to discharge a worker at will and without cause is strong evidence for the right of direction and control. When it is not clear whether you have the right to direct and control the worker, you must look further into the actual working relationship by weighing the ten secondary factors.
Secondary Factors
Depending on the type of relationship and the services performed, each factor varies in importance. Consider each factor independently, then consider them as a whole:
- Is the worker engaged in a distinct trade or occupation? Does the worker make his or her services available to the general public? Does the worker perform work for more than one firm/company at a time? Does the worker hire, supervise, or pay assistants? Does the worker have a substantial investment in equipment and facilities?
- Is the work done without supervision? In the geographic area and in the occupation, is the type of work usually done under the direction of a principal without supervision?
- Is the work highly skilled and specialized? Is the worker trained by the principal? Does the worker personally perform the services?
- Does the principal furnish/provide the tools, equipment, materials, supplies, and place of work? Does the worker perform the services on the principal’s business premises?
- Are the services provided on a long-term or repetitive basis?
- Method of payment – Is the worker paid based on time worked or on completion of the project?
- Are the services an integral part of the principal’s business?
- What type of relationship do the parties believe they are creating?
- What is the extent of actual control by the principal? Does the worker have the right to terminate the relationship without liability? Does the principal provide instructions on how to do the work? Does the principal establish the work hours or the number of hours to be worked? Does the principal require the work to be done in a particular order or sequence? Does the principal require oral or written reports from the worker?
- Is the work performed for the benefit of the principal’s business?”:
http://www.taxes.ca.gov/iCorE.bus.shtml
https://www.dir.ca.gov/dlse/faq_independentcontractor.htm
2. Contractor agreements. Regardless of the business structure, it is advisable to have written agreements with qualified independent contractors to explain the job responsibilities, compensation arrangements, tax and insurance responsibilities, and other important terms of the arrangement. Businesses typically have insurance provisions in written independent contractor agreements that explain the required insurance coverage (liability, workers’ compensation, bond, etc) and that require contractors to provide a Proof of Insurance Form that demonstrates that they have the insurance required under the contract. In addition, it is advisable for businesses that use independent contractors to obtain the proper liability insurance coverage to protect themselves from the actions of contractors who fail to maintain the required insurance or are otherwise named in legal actions involving their contractors. You should consult your business insurance agent to determine the recommended insurance coverage and other risk management implications when engaging independent contractors.
For drafting and review with your lawyer, you can find a template for an Independent Contractor Agreement through your GSB Account under Applications then Legal Forms. Also, you can find sample independent contractor and other agreements (some free and others for a fee) that you may be able to adapt to your particular situation at websites like the following:
https://www.docracy.com/0rgkbvacolg/independent-contractor-agreement-template#
https://www.upcounsel.com/independent-contractor-agreement
https://www.lawdepot.com/contracts/independent-contractor-agreement/#.VtH84fbSmos
http://www.ilrg.com/forms/st_employment.html
http://secure.uslegalforms.com/cgi-bin/forms/query.pl?S-T-US-B-contractor
Links and references to sample and template documents have been provided pursuant to your request. Templates and sample documents can be very useful but businesses should exercise caution in the use of such documents. Understand that not all templates are created equal, with many being created for a narrow set of requirements. A particular template will not be warranted to cover every provision that may be required by a particular set of business circumstances. Studying the language included in various samples and templates will improve your level of understanding related to the subject of your particular agreement and may help you articulate your business objectives related to an agreement, but be aware that many, perhaps most, agreements should be prepared by your lawyer to provide greater assurance that your interests have been protected.
As a LegalShield member, you can contact your Provider Law Firm for advice on contracts and agreements. The advice required may be considered a document review when your lawyer is provided with a completed and well-conceived agreement, but be aware that a poorly drafted document or one that is not well suited for your specific situation will likely need to be redrafted rather than simply reviewed.
3. Contractor tax reporting.
a. Form 1099-MISC. Under current tax law, businesses report cash and check payments for services rendered by non-corporate vendors, such as qualified independent contractors, on Form 1099-MISC, which is filed annually and, in the case of services, only when payments total $600 or more during the calendar year. Businesses are required to provide non-corporate vendors and the IRS with copies of Form 1099-MISC for the preceding calendar year by January 31st. Copies of Forms 1099-MISC also must be submitted to certain state taxing authorities for the preceding calendar year by February 28th (some states have adopted the IRS’ January 31st due date); however, most states obtain their 1099 information through data sharing arrangements with the IRS. Forms 1099-MISC submitted to the IRS must be accompanied by Form 1096, Annual Summary and Transmittal of U.S. Information Returns. Forms 1099-MISC and 1096 must be submitted to the IRS electronically or using machine readable (optically scanned) forms that you can order directly from the IRS at 1-800-TAX-FORM (1-800-829-3676). You can find and review Forms 1099-MISC, 1096 and the filing instructions at the following IRS websites:
2017 tax year forms (for reporting amounts paid in calendar year 2017)
https://www.irs.gov/uac/about-form-1099misc
https://www.irs.gov/uac/about-form-1096
b. Form 1099-K. It is important to note that businesses only report cash or check payments on Form 1099-MISC. Payments made by credit or debit cards as well as those made through third-party networks such as PayPal, Amazon.com and Google are reported by the payment processors on Form 1099-K. The following is IRS and related information on the topic:
https://www.irs.gov/Tax-Professionals/Third-Party-Reporting-Information-Center
http://blog.aicpa.org/2012/12/merchant-card-reporting-compliance-raises-its-head-again.html
However, the regulations contain an “aggregate payee” rule that requires companies who accept credit or debit card payments and third party network payments for other parties who work for them as independent contractors to report those payments on Form 1099-K. You can review Form 1099-K and its instructions at the following websites:
2017 tax year forms (for reporting amounts paid in calendar year 2017)
https://www.irs.gov/uac/form-1099-k-merchant-card-and-third-party-network-payments
c. Form W-9. The basic tool to properly identify and manage your Form 1099 reporting and potential tax withholding obligations with vendors is Federal Form W-9, Request for Taxpayer Identification Number and Certification. Form W-9 is used by businesses to obtain a vendor’s, including an independent contractor’s, TIN or Taxpayer Identification Number (Social Security Numbers in the case of an individual or Federal Employer Identification Number (EIN) for a business) and to have the vendor certify that they are not subject to backup withholding. When a vendor fails to provide you with a TIN, you will be required to withhold federal income tax from your payments to that vendor under the backup withholding rules. For 2017 the backup withholding rate is 28%. You can locate Form W-9 and instructions and review the backup withholding rules at the following IRS websites:
Form W-9:
http://www.irs.gov/pub/irs-pdf/fw9.pdf
http://www.irs.gov/pub/irs-pdf/iw9.pdf
Backup withholding:
http://www.irs.gov/taxtopics/tc307.html
http://www.irs.gov/Businesses/Small-Businesses-&-Self-Employed/Backup-Withholding-B-Processes