A business owner needs to first determine the amount of control that is desired over the worker. Do you want the worker to account for his time through clock devices or time cards? Do you need to train the worker? Do you want to supervise the worker’s job performance? Do you want to exercise disciplinary rights and performance evaluation systems? And, very importantly, do you want exclusive rights to the worker’s services?
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If you are answering yes to some or all of these questions, you don’t have much of a choice — you must hire the worker as an employee, because you have control over the worker. You lose that control by utilizing independent contractors.
It is important to understand the differences because if the IRS becomes aware of your improper classification of the worker, you will be assessed payroll taxes and penalty/fees for the entire length of the worker’s relationship with you.
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So why would a small business even consider working with independent contractors? For one thing, you won’t need to collect the employer’s portion of payroll taxes. Secondly, many entrepreneurs don’t have time to keep updated on constantly changing payroll laws and regulations. They also don’t want the fees associated with having a third party administer their payroll — especially if the staff size is very small.
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The problem is, most owners forget the basic elements of an independent contractor relationship. Think of the two words involved.
First, there is “independent.” That’s right, your contractor must be free to perform similar work for others — including your competition.
Second, there is the element of having a contract in place. With Ohio being a “employment at will” state, most employers disdain contracts. If you are going to classify a worker as an independent contractor, you’d better have a contract in place. That contract must include all the essential parts of a legal contract – including a beginning and end date. Failure to have a contract in place is a sure way to have the IRS reclassify your worker as an employee.
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Your payments to an independent contractor are reported via IRS form 1099, while employee compensation is reported via W2 statements. This can be problematic in a situation where the contractor failed to make estimated tax payments and is suddenly shocked by a huge end-of-year income tax bill. This can provoke the worker to claim an employment relationship, and the burden of proof is always on the owner’s shoulders.
Other trouble areas are Workers’ Comp and Unemployment. Always make sure your contractor proves they have their own BWC, unemployment and liability insurance. Failure to do so could make the relationship one of employment by IRS or state determination. The safest answer to the dilemma is to make your workers employees, and find a good, affordable payroll service to handle your payroll.
HAVE A QUESTION?
This monthly column aims to help small-business owners navigate the resources available to them. Have a question about starting or managing a business? Email questions to laura@hamilton-ohio.com for possible inclusion in an upcoming column.
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