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What to Know Before Hiring Independent Contractors

by / ⠀Entrepreneurship / April 18, 2022
Using independent contractors may help you save money on employee-related expenses, including payroll taxes, benefits, and overtime.

Using independent contractors may help you save money on employee-related expenses, including payroll taxes, benefits, and overtime.

While it may be tempting to categorize some of your staff as independent contractors, you’ll want to ensure your company is doing it correctly with the increasing danger of fines. Make sure you study the subject.

The Internal Revenue Service and the United States Department of Labor have joined up with an increasing number of states. The purpose is to exchange information and resources that may aid in the discovery of worker mis-classification infractions.

Employers in breach may be liable for overtime. Then back taxes (including the workers’ half), penalties and interest, and legal expenses. In addition to perhaps paying back pay (if minimum wage standards have not been satisfied).

Adverse publicity and decreased employee morale are less quantitative consequences. Furthermore, the fines and penalties issued rise in proportion to the severity of the infringement.

The IRS is clear that there is no magic formula for determining whether a person is an independent contractor or an employee. It all relies on the circumstances of the case.

In general, managers should assess whether they have the authority to regulate the job output and how the employee does the task. The worker’s status is unaffected by whether or not you use this privilege. There are occasions, for example, when businesses give minimal advice or control to highly experienced staff. The issue is whether you have the legal authority to do so.

The IRS determines independent rules.

How does the IRS determine how much control an employer has over how people do the job?

The IRS’s Common Law Rules encompass three significant factors: behavioral control, financial control, and relationship type. No one aspect is important. Instead, you must assess the entirety of each circumstance.

You may also use the Department of Labor’s Economic Reality Test to determine if the Fair Labor Standards Act (FLSA) applies to you. Its six criteria coincide with those of the IRS. It also evaluates if the worker has a legitimate firm that does not supply services that are essential to yours.

So, how can you establish that someone is an independent contractor rather than an employee? The best paperwork demonstrates that the individual has a legitimate company apart from yours. Documentation may also demonstrate that the person has complete control over their employment.

Their labor is not an essential component of what your organization offers. Indeed, the worker is free to earn a profit or a loss and be recruited by others (check with the IRS for further information). Furthermore, establish a vendor file for each independent contractor that contains the following information.

A written agreement.

Outline the nature of the partnership since just stating that someone is an independent contractor does not make them one.

Indicate the project’s intended outcomes, fee, and completion date(s). The contract should say that the worker must use their equipment/tools.

Moreover, they are allowed to recruit others without your permission. And that they provide liability insurance for their employees. Take down the contractor’s business and tax identification numbers. Both parties sign the contract and write a new contract for each new project.

Evidence of a legitimate and distinct business. Keep a copy of any letters printed on business stationery, business cards, brochures, or adverts. Print a copy of a relevant page from the contractor’s website, online advertising for services, or copies of emails outlining the services provided.

Invoices.

You should base all payments to the contractor on the invoices they have supplied.

Do not accept expenditure reports from an independent contractor. Mileage and any equipment purchases or supplies are part of their company expenditures, not yours. Keep all invoices and make sure they correspond with Form 1099, which you must send to the contractor after the tax year.

W-9 form for the independent contractor.

For each independent contractor, have a fully completed W-9 on file.

If the contractor does not mark the box exempting themselves from tax withholding, legally you must withhold taxes at a rate of 28%. Check that option and submit your self-employment taxes if you are an independent contractor.

With today’s stricter labor rules, firms must do their research before categorizing someone as an independent contractor. In terms of an independent contractor’s standing, the following conditions may raise red flags:

  • A former employee gets rehired to undertake work comparable to their previous employment, even if the position is temporary or part-time.
  • An intern does real work rather than simply shadowing or studying. Check out the six inter-related criteria.
  • You give the worker the necessary equipment, supplies, tools, and continuing office space.
  • The worker either replaces or supervises one of your workers.
  • The partnership is continuing and long-term instead of working per project basis.

The last concern is that state laws may vary significantly from federal ones. It is conceivable for classification of a worker as an independent contractor for IRS reasons while paying workers’ compensation or unemployment insurance payments on their behalf under state law. Check your state’s rules on independent contractors to ensure you’ve covered all of your bases.

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