One of the simplest methods to reduce your corporate taxes is to hire independent contractors. A business does not have to withhold any amounts from payments made to independent contractors and more importantly, does not have to pay the employer’s share of unemployment, Medicare and Social Security taxes on a compensation paid to a worker.
The rules regarding who is an employee versus an independent contractor are based on common law (sum of past rulings made by judges in a court of law establishing precedent, rather than regulations). This means each case is evaluated on its own merits, but there are a few general guidelines you can follow to ensure the person you have hired as an independent contractor is not viewed as a business employee (in which case you would be liable for a lot of back taxes, along with interest and penalties due to the IRS).
There have been countless cases filed against businesses by the IRS claiming a worker qualifies as an employee rather than an independent contractor. This has provided the basis for three main categories which are analyzed by a judge in such grievances.
If a person is in legal control of deciding what and how he or she will provide services to your company, you have an independent contractor. If that legal right resides with the business, whether they use it or not, than the worker may be qualified as an employee by the IRS.
There are four categories the law will consider when classifying if a person has control over their behavior: types of instructions provided, degree of instruction, evaluation system and training. Type of instructions a business will give an employee include these commands as when to work, where to work, which workers to hire to aid in the job, where to purchase supplies and in what sequence to perform the job.
The more detailed instructions a person is provided by a business, the higher the degree of instruction and greater probability the worker is an employee. An employee will also be evaluated and trained periodically by a business.
Independent contractors should have sole control over their financial decisions (without undue influence from the business).
Courts look at five different categories under the financial aspect of a worker: significant investment, unreimbursed expenses, opportunity for profit or loss, services available to the market, method of payment. An independent contractor typically pays for his or her own equipment which is used to provide services to others. There probably will be a lot of unreimbursed expenses as the contract with the business will normally outline payment for services.
Some expenses will be ongoing, regardless of whether the worker has clients to work for or not. They will also have a risk of making a profit or loss as they may have to invest in tools of the trade, but sales (work) is not guaranteed. Independent workers may advertise their services as they feel is necessary and will often be working for more than one client at a time. In some, but not all cases, independent workers will be compensated via a flat fee for rendering a service as opposed to a time based fee like weekly pay slips paid to employees.
The type of relationship between the business and contractor will show whether a person is an employee or an independent worker.
This relationship is established based on four factors: written contracts, employee benefits, permanency of relationship, services provided as key activity of the business. A contract may specify a worker is independent contractor, but such a contract may be declared null and void if according to other situational factors the IRS comes to the decision that a person is an employee. An independent worker will not get compensated with benefits similar to those of an employee (paid sick and vacation days, pension plan and disability insurance).
Also, there is generally a contract term with an independent worker, but if the person is hired indefinitely or if the contract is renewed constantly that may show an employer-employee type of relationship. Finally, an independent contractor will rarely provide services which are key to the operations of the business (for instance, an auditor hired by a chartered accounting firm).
A small business can greatly reduce their tax burden by hiring independent workers rather than appointing employees. However, the rules are flux and depend on situation to situation. The above are guidelines issued by the IRS, but there is not one single fact which can ensure your worker will not be qualified as an employee by the IRS. The IRS and courts look at the overall situation of a worker to decide on his or her classification.
E WATERS