The Tax Ins and Outs For Using Contract Workers and Strategies to Help You Plan Ahead

In recent years, trends are showing that more companies are using contract workers.

It used to be that most employees had fixed hours and stayed at a company for 40+ years. This trend has been decreasing as more companies hire contract workers. Not only does this practice provide more flexibility to the hiring company, it also provides these contract workers greater flexibility in the work they pursue. In fact, according to survey research conducted by Lawrence Katz of Harvard and Alan Krueger of Princeton from 2005 to 2015, 94% of job growth was in the alternative work category, and over 60% was due to the rise of independent contractors, freelancers, and contract company workers. This constitutes nearly 10 million jobs!

If you decide to use contract workers in your business, you need to know the tax rules that apply, and how they differ from employee tax rules. 

If you cross the line between contractor and employee designation — even unknowingly — the Department of Labor (DOL) and Internal Revenue Service (IRS) can penalize you with some steep fines. Here are some basic tips regarding contract workers:

Classify Your Independent Contractors Correctly

Make sure that you correctly classify your contract workers. You need to understand that:

• Contract workers control their own work hours and the way they complete their tasks. Only the result of the work is under the hiring company’s control.
• While you can supply tools or equipment, significant investments in the equipment used are generally incurred by the contract worker. In addition, contract workers invest in their own training and licensing. 
• Contract workers are typically hired on a short-term basis for a specific task. If there is a perception that the relationship is permanent, it can be seen as evidence that the relationship is more of an employee / employer arrangement.

Sometimes it is difficult to determine where the line falls between contract worker and employee. If you have questions, let’s talk. You can also review the IRS definitions here.

Get Everything in Writing

When hiring a contract worker, you’ll want your agreement in writing. Specific language in your contract should state that the worker is an independent contractor. Additionally, specify the beginning and end date of the agreement. (Please note that even with all these precautions, a written contract may not be sufficient evidence to prove that your worker is a contractor rather than an employee.)

Limit Supervision and Control

When hiring a contract worker, you must limit supervision. Typically, expectations are clearly outlined and a general timeline is given, but the contract worker is free to determine their own hours as long as the project is done within the time frame. In sum, contract workers:

• Set their own hours
• Determine their own work process
• Require performance issues to be addressed through contract terms and not as disciplinary issues

Do Not Require Exclusivity

Contract workers should not be limited to providing services for your business alone. You can write in a non-compete and you should have a signed privacy policy in place, but anything more could be considered too restrictive. 

Be Transparent with Third Parties

There should be a clear line between employees and contract workers. In other words, you can’t lead third parties to believe that your contract workers are your employees by assigning them work email addresses, ID badges, etc. This blurring of the line outwardly can pose a problem when it comes to tax classifications.

Get All Paperwork in Order Prior to Hiring a Contractor 

In addition to a contract, a non-compete agreement, and a signed privacy policy, be sure to get a completed W9. You can download the Form W9 directly from the IRS website here. Having this form completed will help you in January as you are preparing to issue 1099s.  Any contract worker to whom you pay over $600.00 and any attorney to whom you pay any amount needs to be issued a 1099. 

The Penalties for Misclassifying

As you can see, the line between contract worker and employee can be difficult to navigate at times. (Here’s a chart from the DOL that outlines the difference visually.) If any of these lines are crossed, the DOL and the IRS will be more likely to lean towards identifying your contract worker as an employee. Consequently, you’ll be responsible for paying back taxes, penalties for income taxes, wage and overtime compensations, Social Security and Medicare funds, and unemployment taxes. You may even need to provide the newly designated employee with benefits. 

We want to help you avoid any such penalties. If you have questions regarding your worker classification, let us help you!