PROTALK CORNER:
Avoid Trouble by Clarifying Independent Contractor Status

Most small-business owners agree that it’s much simpler to treat someone as an independent contractor. It allows you to circumvent the administrative red tape and taxes that come when someone is hired as an employee. Recently, the IRS and state employment agencies have become more aggressive in their efforts to ensure that businesses are not improperly classifying workers as independent contractors when they are really employees. The reason for the government’s vigilance all boils down to taxes.

The problem is that business owners typically classify workers as independent contractors thinking there is little chance the IRS or the state is ever going to question them. And, actually, they are right. The real worry isn’t governmental agencies; it’s the people you are hiring. The most common causes for a business being challenged on this issue are workers who get fired or injured on the job and file a claim with the unemployment office or the workers’ compensation bureau. Soon after, the business owner finds a state agency notice in the mail questioning the status of the worker as an independent contractor, rather than an employee.

If it’s determined your ex-worker didn’t qualify under the definition of an independent contractor, he or she becomes eligible for unemployment benefits. Now you’re liable for back unemployment taxes, penalties and interest. You’re also vulnerable to an audit of all your workers, past as well as present, and could find yourself liable for paying back taxes and penalties on them. Since all states share their employment wage information with the IRS, you might also receive a notice from the federal government demanding their unpaid taxes, along with penalties and interest.

As you can see, misclassifying a worker can become a very expensive error. To avoid trouble, small-business owners need to understand that a true independent contractor is really a business. Just because you and another person agree to have an independent contractor relationship doesn’t make it legal. Clarifying who is an independent contractor and who isn’t can be confusing. It helps to follow a simple rule: anyone who doesn’t receive a W-2 is a sole proprietor, partnership, corporation or limited liability company. You can review IRS guidelines for defining an independent contractor by downloading publications 15 and 15-A at www.irs.gov.

If you use independent contractors, be sure they look and act like a business. If they sell services to the general public or other businesses and present themselves as a business you can probably safely treat them as independent contractors. Here are a few other guidelines to consider:

• Use written agreements. Independent contractor agreements can be found in office supply stores, small-business books and on Web sites that offer free legal documents. It’s also a good idea to have your accountant and attorney review the agreement.

• Complete a W-9 form. This form, similar to a W-4 for employees, provides the independent contractor’s business name, federal I.D. number or Social Security number, and other information pertinent to their business.

• Get business information. Keep a copy of the contractor’s business card, letterhead, etc. If they are operating under a business name, get a copy of their DBA (doing business as) filing. If they don’t have any of these, it’s probably questionable if they are operating as a real business.

• Require invoices. Make sure contractors provide an invoice before you pay for any work they do.

• Make checks payable to a business name. Don’t make checks payable to an individual unless the independent contractor does not have a formal business name. Never pay in cash, always by check.

• Issue 1099 forms. If you pay an independent contractor more than $600 a year the IRS requires you to issue a Form1099. It’s in your best interest to issue 1099s to every contractor, regardless of how much you pay them.

The best way to keep out of trouble is to make sure that independent contractors really are in business for themselves. If you can’t convince yourself they are a legitimate business, it will probably be difficult to convince the IRS or your state employment office.

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