Because the Internal Revenue Service (IRS) wants its money from payroll deposits as quickly as possible, it doesn’t take kindly to business owners who misclassify employees as independent contractors. That is because employees pay taxes out of every paycheck through automated withholding while independent contractors only submit tax payments quarterly or occasionally, annually. As a business owner, it’s important to understand how to avoid IRS misclassification that can lead to significant fines and other potential sanctions against your company.

Do You Treat the Worker as a Subordinate or a Vendor?

When you act in the capacity of someone’s boss, it means you have the right to determine work hours and monitor the employee’s performance. This typically means regular performance reviews. You also provide training, equipment, and a space for the employee to work at a physical property that you own. While it’s more common for independent contractors to work from home, some regular full-time or part-time employees do as well. The difference with the latter is they only work for you and according to a schedule that you set.

When you work with an independent contractor, you should treat it like any other vendor relationship. You are also this person’s client and may be one of several that he or she works with at the same time. You typically don’t provide extensive training to an independent contractor beyond sharing knowledge needed to complete the project. The business relationship between the two of you normally ends once the project does, although you are certainly free to work with the same contractor again in the future.

Do You Have a Written Agreement with the Worker?

You can avoid accusation of IRS misclassification by ensuring that you have a written contract with an independent contractor at the start of your business relationship. It should outline the duties of the assignment, the expected completion date, the amount of compensation per project, and how the contractor will receive the compensation. One of the main things that distinguishes an independent contractor from an employee is the expectation that the latter will remain with your company until terminated or putting in a work separation notice.

Besides the expectation of a permanent working relationship, a person is an employee if you provide benefits such as health insurance and paid vacation and sick time. Another area where employers run into trouble with IRS misclassification is hiring a contractor to complete core business services. The reason for this is that you will control and direct the activities of the contractor, which would move him or her into the category of employee.

What Type of Financial Agreement Do the Two of You Have?

Independent contractors normally pay for their own equipment such as computer and software programs to create graphic designs. While you pay your regular employees by the hour or a set salary, you risk IRS misclassification if you do this with contractors. They should always receive payment by the project.

The amount of assumed risk is another major difference between employees and contractors. Employees do not invest their own money into the job and know that they will receive a paycheck. Independent contractors, on the other hand, may lose money from expenses that are not reimbursed or when not producing work to the client’s satisfaction. The possibility of sustaining a loss is unique to independent contractors.

Rickhoff & Associates Can Help You Avoid IRS Misclassification

Our experienced small business associates work with several business specialties to help companies become as profitable as possible. If you have questions about IRS classifications or anything else related to the financial aspect of your business, we welcome you to contact us at 618-632-1994 for our Illinois location or 636-227-9320 for our Missouri location to request a consultation.


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