Free-Lance Employment/Independent Contractors

Free-lance employees, also known as independent contractors, are individuals who work on their own, without a long-term contractual commitment to any one employer. A free-lance employee usually performs services or completes work assignments under short-term contracts with several employers, or clients, who have the right to control only the final result of the individual's work, rather than the specific means used to get the work done. Examples of positions held by independent contractors range from doctors and computer programmers to maids and farm workers. Free-lance employment can offer a number of advantages to individuals, including flexible work arrangements, independence, variety, and some tax deductions. It can also hold some pitfalls, however, such as assuming risk in business dealings, paying self-employment taxes, and taking personal responsibility for health insurance, disability, and retirement coverage.

Specifically, individuals who are classified as independent contractors can deduct work-related expenses for tax purposes. In contrast, the first 2 percent of expenses are not deductible for those classified as employees. In addition, independent contractors often qualify for tax deductions for using part of their home as an office and for salaries paid to other people, while employees usually do not. Independent contractors also have the benefit of sheltering 15 percent of their annual income, or up to $30,000, for retirement, while employees are limited to $15,000 annually. Finally, independent contractors must pay the full amount of Social Security and Medicare taxes and make quarterly estimated tax payments to the federal government. Employers must withhold taxes for their employees and pay half of their Social Security and Medicare taxes.

Free-lance employment boomed in the United States during the 1980s, as many companies sought to reduce their payroll costs in order to remain competitive. Instead of hiring new employees and paying an additional 30 percent or more in payroll taxes and benefits, many companies chose to make "work-for-hire" arrangements with independent contractors (ICs). Businesses, and especially small businesses, can gain several advantages from such arrangements. For example, employers are not responsible for paying taxes for free-lance employees, and they avoid the high costs of providing health insurance, paid vacation and sick leave, and other benefits often granted to regular, full-time employees. In addition, employers that use independent contractors relieve themselves of the risk of costly litigation over hiring, promotion, firing, and other employment practices. These employers simply file Form 1099 with the government to report the total compensation paid to each independent contractor for the year.

There are disadvantages to using independent contractors instead of hiring a staff as well. The loyalty of a freelance worker is not likely to be as great as that of an employee who is a part of the organization. The knowledge that an independent contractor gains about how a company likes things done is also in greater jeopardy than would be the case with an employee. Thus the investment in working with somebody is more easily lost with an independent contractor. However, small businesses often lack the financial security to make the longer-term commitment that taking on an employee requires. Hiring free-lancers is, consequently, an attractive option when help is needed.

FREE-LANCE TREND CAUSES CONTROVERSY

The boom in free-lance employment led to increased scrutiny by the U.S. Internal Revenue Service (IRS) in the early 1990s. Section 1706 of the Internal Revenue Code provides a 20-part test to determine whether workers are employees or independent contractors. The IRS began using this test to reclassify many independent contractors—particularly those engaged in high-paying professions—as employees in order to eliminate tax deductions and increase tax revenues.

The IRS has made reclassification of independent contractors a priority, since fraudulent IC arrangements are estimated to cost the government between $6 and $20 billion per year in tax revenue. The IRS would also argue that they are attempting to protect individuals from unfair treatment by employers—such as being fired and then rehired as an independent contractor without benefits—but few of the reclassifications have involved exploited low-wage laborers, because they generate minimal tax revenues.

Although the controversy surrounding free-lance employment has received increased attention in recent years, it is not new. As early as the 1960s, the IRS started looking more closely at household employees—such as maids, nannies, and gardeners—who often received income "under the table" and thus did not pay taxes. The main cause of dissention over current application of the law is that it often tends to penalize individuals who wish to be classified as independent contractors and take advantage of tax breaks (as well as the small businesses that depend on them), while it often fails to protect individuals who should be classified as employees and be eligible for benefits. For example, the IRS would be likely to review the case of a highly paid engineer who markets her services to several companies as an independent contractor and deducts various expenses of doing business. However, the IRS would be unlikely to review the case of a migrant farm worker who is employed by a large producer but, as an independent contractor, makes less than minimum wage and receives no disability or old-age benefits.

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