How to Protect Your Business When Hiring Independent Contractors

By QuickBooks

5 min read

To hire or not to hire?

That is the question many small business owners are facing today. As your business grows, you need to a strong team to help you achieve the next level of success. But it’s scary to think about taking on additional staff, especially in a dubious economy. Additionally, if you hire someone who isn’t the right fit for your company, experts say it can cost more than 20% of the employee’s salary to recruit and hire another candidate.

These factors are causing many small business owners to choose freelancers or independent contractors instead of adding full-time employees to their team.

Why Should I Hire Independent Contractors?

Independent contractors are considered to be in business for themselves; therefore, your company is not required to pay state and federal payroll taxes or other employee benefits, which can add 30% or more to payroll costs. Instead, the independent contractor is expected to pay his or her own estimated taxes directly to the IRS every quarter. Furthermore, you don’t have to offer freelancers vacation time, sick days, overtime pay, etc.

Sounds like a sweet deal, doesn’t it? Don’t rush to judgment.

The ease and cost-savings of hiring freelancers is one of the many reasons why the number of freelancers in America is rapidly increasing. According a Freelancers Union’s study, “Freelancing in America 2015 Report,” 54 million Americans are now doing freelance work.

Independent contractors are an attractive alternative to hiring full-time employees, but classifying a worker as an independent contractor exposes your company to a considerable amount of risk. The IRS, the Department of Labor and other government agencies at the national and state levels are cracking down on who qualifies as an independent contractor and who doesn’t.

You may have heard about recent charges by the California Franchise Tax Board against Uber, which argue that its drivers should be classified as employees rather than independent contractors for tax purposes. That could be a significant setback for the burgeoning transportation company. While Uber may have the firepower to push back against the tax man, your small business probably doesn’t. So it’s better to make smart, well-advised decisions about classifying your workers before it’s too late.

How to Determine If Your Worker Is a Contractor

Various state and federal agencies and taxing authorities have a variety of tests to determine whether a worker is properly classified as an independent contractor or not. The most commonly recognized assessment is the IRS’s 20-factor test, most of which is listed below. I’ve only included some of the highlights so you can get an idea about the criteria these agencies consider when making a determination.

To be classified as an independent contractor, the individual must:

  1. Have the ability to set his/her own hours and do the job in his/her own way.
  2. Have the ability to use his/her own methods as opposed to being required to undergo training from the purchaser of his/her services.
  3. Accept a risk. In other words, he/she can earn a profit or suffer a loss from the activity.
  4. Be able to assign others to do the job and is not required to do it personally.
  5. Be hired for one job and not have a continuing relationship with the company.
  6. Have more than one client at a time.
  7. Must pay his/her own business and traveling expenses. NOTE: The employer may later reimburse him/her for those expenses.
  8. Not work on the employer’s premises and use his/her own office, desk and equipment.
  9. Be paid on a commission basis or on a per-project basis rather than by the hour, week or month.
  10. Must agree to complete a specific job and be responsible for the satisfactory completion, or he/she is obligated to make good for any failure.

Many business owners believe a written Independent Contractor Agreement can establish the nature of the relationship with the worker. But while an agreement should clearly spell out the scope of work, when the work is to be performed and the independent contractors’ compensation, it won’t be the determining factor in preventing a contractor from being classified as an employee by an auditing agency.

There are a plethora of laws governing independent contractors. As a result, a worker may be considered an independent contractor under one, but deemed an employee under another. Therefore, if you have doubts about how to classify a worker’s status, check with your legal counsel or a human resources professional. Misclassifying an employee can be a costly mistake, as you may be liable for back taxes, interest and penalties. So be sure to protect your small business by performing due diligence and making wise decisions.

For a simple way to determine if your worker is an independent contractor, see our Independent Contractor vs. Employee Wizard. If you’ve hired independent contractors this past year and need to manage your taxes, check out our guide to filing 1099s for businesses that employ independent contractors.

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Information may be abridged and therefore incomplete. This document/information does not constitute, and should not be considered a substitute for, legal or financial advice. Each financial situation is different, the advice provided is intended to be general. Please contact your financial or legal advisors for information specific to your situation.

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