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Is that Independent Contractor Actually an Employee?

Employers have weathered the economic storm in a variety of ways. Some have replaced laid-off workers with independent contractors, usually known as “consultants,” or “freelancers.” The advantages to employers are many: no payroll taxes, social security or benefits to pay. And, no guilt when it’s time to end the contract—freelancers are used to short-term employment! Independent contractors can be the answer to one of an employer’s biggest headache—payroll.

The downside is when that invisible line is crossed and an employer misclassifies an employee as an independent contractor. Whether it is done intentionally or not, the IRS does not like missing out on revenue it is owed.

And since deficits are so high, those misclassifying employees will be a target of the additional 100 agents the IRS is hiring for fiscal year 2011. Random audits of 6,000 businesses over the next three years is planned.

How to Determine Whether a Worker is an Employee or Independent Contractor
According to the IRS, it’s a matter of degrees of control and independence in the following three categories:

  • Behavior: Do you control what the worker does and how they do their job?
  • Financial: Do you control the financial aspects of the worker’s job, such as when they are paid and who provides and pays for tools, supplies, etc.?
  • Type of Relationship: Is there a written contract? Are there benefits provided to the worker? Is the work performed a key aspect of the business?

There are no real guidelines to help employers determine whether a worker is an employee or independent contractor. The IRS recommends businesses weigh all these factors and acknowledges that factors that are relevant in one situation may not be relevant in others. The keys, the IRS says, are to “look at the entire relationship, consider the degree or extent of the right to control, and document each of the factors used” in making the determination.

If the determination cannot be made, either party may file a Form SS-8 and the IRS will review the form and officially determine the worker’s status.

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