It should be easy to distinguish an independent contractor from the other employees in your department.
Independent contractors are:
- Paid differently.
- You don’t have to provide benefits or pay Social Security, Medicare or Unemployment taxes on their wages.
- They also don’t normally come to the office every day, attend regular meetings or work together on a team with other employees.
The more a contractor resembles the other employees in your department, the greater the risk that you’ve misclassified an employee as a contractor. It doesn’t matter that you didn’t do it intentionally and it doesn’t matter that the contractor agreed to the terms. If the Department of Labor or the IRS determine you’ve made a mistake, you will be required to hire the individual retroactively, pay back wages and taxes for up to three years in the past and pay substantial penalties and fees that could cost an additional 40 percent of the contractor’s compensation each year for the past three years.
Common Law Rules
It’s ultimately up to the Department of Labor and the IRS to determine if an individual qualifies as an independent contractor. If you hire a contractor who believes he should be an employee, he can ask the IRS or the Department of Labor to determine the proper classification. To make that decision, the IRS considers 20 factors that indicate whether an individual is an independent contractor or an employee. These 20 factors fall into three categories called “common law rules.”
Work Location Hours
The first common law rule has to do with the amount of control you exhibit over an individual’s behavior, keeping in mind that the individual is a contractor, not an employee. Independent contractors must have the freedom and flexibility to accomplish the agreed-upon work whenever and wherever they want. For example, you are not permitted to require an independent contractor to work during certain hours of the day and you can’t require an independent contractor to work onsite at your location. According to the IRS, the ideal arrangement is for an independent contractor to work from his own office.
Providing Instruction and Direction
When you hire an independent contractor, you’re usually buying knowledge, skills and experience. If you have to train the independent contractor to perform the work she’s doing, she might not qualify as an independent contractor. Independent contractors are also expected to have their own methods and techniques they use to perform work. While you can provide specifications to a contractor for a project she’s working on, you can’t require her to perform the work in a certain manner. If you’re providing close, over-the-shoulder direction to an independent contractor, it’s a red flag that she might be a misclassified employee.
Fixed Fee or Range of Fees?
The second common law rule is about financial control. The ideal financial arrangement between you and an independent contractor is a fixed fee or range of fees to perform a specific project or well-defined body of work. The contractor should build overhead expenses and an appropriate profit margin into the price he quotes. If it takes him longer to complete the project than he anticipated, he assumes the financial risk of not making a profit. If you pay an hourly rate to a contractor, it makes the IRS wonder if he’s really an independent contractor.
Tools and Equipment
We Independent contractors are also expected to invest in the tools and equipment they need to perform the work they are hired to do. For example, a contract programmer, should have his own office and his own computer that he uses to program solutions. When you provide an office and a laptop to a contractor, she starts to look less like a contractor and more like an employee.
While an independent contractor works on a project for you, he’s also free to bid on other projects and accept work from other clients. You can’t require an independent contractor to stop soliciting business or to refuse business from another client just to work on your project.
One of the Team
The third common law rule has to do with the nature of the relationship between the company and the independent contractor. You can’t hire an independent contractor indefinitely. There must be a starting and ending date to her assignment. If you hire an independent contractor and put her on a team with your employees, and she performs essentially the same work as everyone else on the team, she’s not an independent contractor according to the IRS.
The U.S. Department of Labor does not look kindly on companies that misclassify workers as independent contractors because it denies the workers protections
and benefits such as minimum wage, overtime, family and medical leave and unemployment insurance. The IRS doesn’t look kindly on companies that misclassify workers either, because it results in lower revenue for Social Security, Medicare and state unemployment and workers compensation funds.
In 2011, the two agencies agreed to share information and work together to reduce the number of misclassified workers. A company that unintentionally misclassifies a worker as an independent contractor might owe the government more than 40 percent of the contractor’s pay for each of the past three years. If the government determines the misclassification was intentional, it can levy additional fines up to $500,000 and can put those responsible for the deception in prison.
We are here to help… Should you have any questions or require further clarification, your Client Relations Manager is happy to assist!