As business owners know all too well, hiring an employee costs more than just paying a salary. Employers generally provide benefits to employees, which can be expensive. Moreover, employers must pay a share of Medicare, Social Security, and federal/state unemployment taxes.
None of the above applies when your company hires an independent contractor – a publicist to get your company’s name in the news, for example, or a freelance website designer. You pay these workers the agreed-upon amount and let them worry about funding their retirement or handling payroll taxes. If that’s the case, why not just use a group of independent contractors to work for your company and do with few or even no employees?
Defining the Difference
The answer is that the IRS is well aware of the advantages of using contractors to perform services for your business. Therefore, the IRS has established rules governing employee and independent contractor classification (see my earlier post, Employee or Independent Contractor?, for overview of these rules). Drilling down, the major difference is a matter of control.
Hiring an independent contractor to do a specific task is fine. You tell the contractor what you want done, and you pay for results. However, if you tell the worker how and when and where the work is to be done, you risk having that worker re-cast as an employee by the IRS.
In some cases, common sense will apply. If that freelancer works on your website while doing other paying jobs for different companies, chances are the IRS will go along with independent contractor classification. On the other hand, if you have a person who works from home as a freelancer but works only on your website, does it more or less full time, and takes direction from your IT staff, you may have a difficult time treating him or her as a contractor.
If you have been misclassifying employees as independent contractors, the penalties can be steep. My office can discuss your workers with you, providing guidance on how to proceed in order to legitimately treat them as independent contractors.