The problem comes when a company wrongly classifies a regular employee as a contractor. Because the penalties for such misclassifications are very steep, and the guidelines strict, it’s best to understand how-to avoid the headaches and liability caused by such errors. Start by recognizing the signs of a regular employee vs. those of an independent contractor. Then be sure to follow the guidelines and you can’t go wrong.
An independent contractor is a person who agrees to provide specific services for a specific price and with specific conditions. For instance, when you hire a freelance writer to create content for your website, that person is typically an independent contractor. She sets her own hours, uses her own tools, does the job in her own way. You simply pay her for the project upon completion.
On the other hand, let’s say you hire that same freelance writer to create content for your website. But instead of her setting her own hours, you inform her she needs to work at your office, between 9:00 a.m. and 5:00 p.m. Monday through Friday, she needs to use your computer, and perform the job exactly as she direct her to. Even though you may call her an independent contractor, and may only pay her a flat rate for the work, rather than an hourly salary, because she looks like a regular employee, your company would most likely be liable for her taxes, and you could also incur expensive penalties for misclassifying her as a contractor.
While there are several benefits to hiring independent contractors, including the lower cost of hiring, the savings in equipment or supplies, and the reduced legal liability, there are also disadvantages. The most expensive is the misclassification which could cost you back taxes that you failed to pay for that worker along with interest and penalties up to 35 percent. You also open your business up to audits, worker’s comp issues and more. It’s better to be safe than sorry and be sure, if your plan is to hire an independent contractor, that you follow the rules from the start.
According to the IRS, an independent contractor typically: is able to lose money or make a profit from the work; offers his services to others; is paid by the job; maintains her own equipment and supplies; works his own hours in his own location; pays her own expenses and other facotrs. While not all of these situations will exist in every contractor situation, the IRS will use these guidelines to determine the proper status should a question or complaint arise.
In the same way, an employee is typically: assigned a work station; given set hours; supplied the equipment and supplies needed; paid by the hour; given specific instructions on how to complete the job; and more.
The safest solution to determine if you are using an independent contractor or a regular employee is to understand the full definition of each and be sure you closely follow the guidelines. This is the best way to ensure you properly classify contractors and employees, and save your company the high cost associated with misclassification of either.