When looking to expand your business and workforce, make sure you understand the difference between hiring an employee and contracting with a subcontractor. The IRS is very strict in their definition and you want to protect yourself and your relationships with employees and subcontractors. This has long been an area of great discussion and disagreement, but at the end of the day we should be in alignment with the IRS so we don’t cause our business unnecessary fines and stress.
The IRS’ position as outlined in IRS Publication 15A is that: Anyone who performs a service for you is your employee "if you can control what will be done and how it will be done." The general rule is that an individual is an independent contractor if you, the person for whom special the services are performed, have the right to control direct only the result of the work and not the means and methods of accomplishing the result.
Areas that government will determine the appropriate classification of employee or subcontractor is based upon are financial control, behavioral control, and the type of relationship of the parties. Remember, the government wants to know if you are calling them a subcontractor instead of an employee for the sole purpose of avoiding paying employee-related taxes.
There are advantages to utilizing subcontractors when you are looking for assistance on an occasional basis, this will save you from paying an employee during times you may not need them on staff. Hiring subcontractors enables you to only pay them for the actual work you need them to do, and no payment is expected for “dead time”. Whereas, when you hire an employee you may be paying them for hours that they are not necessarily needed and this can increase your costs if not managed well.
5 key ways to protect yourself when designating a worker as a contractor:
- Ensure you have each worker sign a W-9. This will capture the data you need to provide a 1099 for services provided.
- Provide 1099’s to all subcontractors you paid for services totaling over $600 in a calendar year, excluding corporations.
- Information needed is: Name, Address, and Tax ID.
- Clearly outline the arrangement with the worker designating that they are a 1099 subcontractor and ensure you maintain a clear distintion regarding the relationship.
- Do not call a contractor an employee or refer to it as payroll expense for their payments.
- Do not offer the contractor things you would not offer any other contractor (business cards, reimbursed general (nonjob related) expenses such as cell phone, etc).
- I often tell my clients that if they would not pay for the expense for me as a contractor, then they shouldn’t pay it to the contractor in question. Keep it objective based on the information provided in Publication 15A.
Employees and subcontractors can sometimes create a blurred line of who is what. It is imperative that you understand the relationships of each and use them wisely in your business. It is normal that we would have both types of workers to meet our everchanging business needs.