Did you know that the IRS and the Department of Labor have teamed up to audit businesses? If that doesn't make you shake in your boots, you either don't employ any contractors or you are hopelessly naive about what a fun and exciting thing it is to have the IRS and the DOL descend upon your business at the same time.
Many small businesses use contractors, and it's fine if you do. But, you need to make sure that your contractors are actually contractors and not, what the IRS calls, "common-law employees."
If the relationship looks like and acts like an employer-employee relationship, it is an employer-employee relationship, regardless of whether either one of you intended it to be so. And trust me, the IRS wants your head on a platter--er, back taxes--if you have anybody classified as a contractor who should really be classified as an employee.
Here are 5 things you should know before you classify someone as a contractor. Please remember that I am not an attorney and am not offering legal advice here. If you have any questions, consult an employment attorney.
Who controls their work? If you recently gave a lecture to a contractor on how he must be to the office no later than 8:32 and, furthermore, long lunches will not be tolerated, chances are this is not a contractor. If you control how, when, and where your contractor does his work, he's most likely classifiable as an employee. Contractors must be independent. While you can certainly require that the contractor meet deadlines and come to appropriate meetings, how he accomplishes that deadline needs to be up to the contractor.
Who owns that computer? I'm a contractor. My computer is on its last leg and I ordered a new one last week. Is Inc.com paying for it? I only wish. But, as a contractor, my equipment is my responsibility. I buy my own stapler as well. This isn't a hard and fast rule. If you've hired someone to come set up your new server, of course she'll be working on your server. But, if you want to argue that the drywall installer you've hired is a contractor, while she's driving your truck and using your tools, it's going to be an uphill climb.
Are you in a targeted industry? Connecticut based employment attorney Daniel Schwartz says that not all industries are created equal when it comes to audits. The following industries are audited at a higher rate:
- property management
- security guards
- cleaning companies
- nail salons
It doesn't mean you are definitely in violation if you work in one of these industries, but expect to be looked at. If you use contractors, it's worth your time and money to make sure you're in compliance with the law and to fix anything--before you get a knock at the door. At the very least, line up a lawyer so that you can call that person immediately upon being contacted by the IRS or DOL. (My non-legal advice is that you offer your government visitor a bottle of water or cup of coffee and a chair to sit in while you wait for your attorney's advice on how to proceed.)
Are you treating your contractor as an employee? Performance appraisals? Health insurance? Is this person's work a key part of your business? No written contract? Very few employees are under contract while most contractors should be. Start dates, end dates, responsibilities, etc, should be clearly spelled out. What should not be spelled out is how the person will accomplish the task at hand.
Is your contractor free to work for other people? Your graphic designer cannot be classified as a contractor if she needs your permission to design a logo for another business. This doesn't mean that your contractor has to have other clients, but it will certainly help your argument if she does. What she does for other people is none of your business.
A failure to meet any one of these qualifications doesn't mean an automatic classification as an employee. But, it does call for a closer audit. Don't just assume that because you've said, "Karen's a contractor" and Karen agrees that the government will see it the same way. For more information, the IRS has contract/employee guidelines posted.