Independent Contractor Agreements

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The benefit to a small company of characterizing a person as in independent contractor is not having to pay employment taxes on wages. An IRS 1099 form is issued to the independent contractor.

Who is an employee? Who is an independent contractor? What difference does it make? The general rule is that an individual is an independent contractor if the payer has the right to control or direct only the result of the work and not what will be done and how it will be done. The earnings of a person who is working as an independent contractor are subject to Self-Employment Tax.

The IRS may scrutinize your independent contractor agreements to determine if the relationship is more properly an employee and employer relationship where FICA tax is owed by the employer. Federal Insurance Contributions Act (FICA) tax is a United States Federal payroll or employment imposed on both employees and employers to fund Social Security and Medicare.

What is the exposure for company’s that misclassify workers as independent contractors who truly should be employee? Federal and State Governments are starting to look at the classification of independent contractors very carefully. If a Company gets it wrong they may be held liable for the unpaid FICA tax, lost benefits to the employee, liability for unemployment insurance compensation, state disability payments, and claims to cover the worker under an employee benefit plan.

A worker is either an employee or an independent contractor. An employer should be cautious when characterizing a person as an independent contractor. If a person only works for one company every day of the week, in the company’s office, and an agent of the company tells them what to do, the likelihood is this person is in employee.

The issue is proper classification. There is an IRS 20 factor test on the subject of independent contractor designation. Independent contractors have more freedom over their work and the ability to contract with a range of businesses. They have flexibility over how a given project should be completed. Independent contractors generally complete work consistent with the terms of an oral or written independent contractor agreement. The fact that a company has a written independent contractor agreement is not determinative of the assessment of whether or not an independent contractor relationship exists.

The IRS 20 factor test has been simplified by consolidating the 20 factors into three main groups, behavioral control, financial control, and the relationship of the parties.

Behavior control: A control test over behavior includes factors related to a businesses right to direct and control how a worker performs tasks. Generally an employee is subject to a businesses instructions regarding when where and how the work is done.

Financial control: This relates to the businesses right to control business aspects of the workers job. Factors examined her include the extent to which a worker has unreimbursed business expenses, whether or not the worker has invested in the trade or industry, the extent to which the worker makes their services available to the relevant market. If a worker is running their own business and working for a variety of different companies it is much easier to classify this person as an independent contractor. Independent contractors typically take on some risk of making a profit or loss with respect to the services provided.

Relationship of the parties: Factors related to the relationship of the worker and the business includes the existence of a written contract which describes the relationship the parties intended to create. Does the business provide the worker with employee type benefits such as insurance, a pension plan, vacation or sick pay? Providing such benefits are indicators of employee status. Is there an expectation that the relationship will continue indefinably, rather than on a short term project basis? Are the services provided by the worker are a key aspect of the services ordinarily provided by the company? Short term projects unrelated to the company’s core business are a hallmark of independent contractor status.

In summary employers should not think of independent contractors as a panacea. If there is any doubt about whether a person is going to be in independent contractor or an employee a company should error on the side of making them an employee. A company that has a lot of independent contractors that are really employees is sitting on a potential liability. If a company chooses the independent contractor path, make sure they are truly an independent contractor, not just by words on paper, but based on what they actually do for the company and how they actually conduct their business. An employer must be comfortable with giving up control over the person. An employer who drafts up an independent contractor agreement, but then exercises control over the workers that is inconsistent with the written independent contractor agreement may be vulnerable. Independent contractors do their work exercising their own judgment and are not under a company’s day to day control. Further, if the workers are completely dependent on the company to make their living, and they work exclusively for the company, it may be a good idea to take another look at the classification for these workers as independent contractors.