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Independent contractors are individuals that you hire to perform a specific task that is not a core portion of your business. Many companies believe that independent contractors are beneficial to the bottom line of the company since a company does not have to worry about benefits, such as health, dental, STD, LTD and life insurance, retirement plans, unemployment compensation and worker's compensation, nor does the employer have to worry about the monetary and administrative costs to their business such as withholding social security and medicare taxes. The problem is that numerous employers use independent contractors improperly, substituting them in place of traditional employees.
The Internal Revenue Service (IRS) has established the most comprehensive analysis to determine if a worker is truly an "independent contractor" or an actual employee. The IRS test was developed to ensure that employers withhold the necessary and proper amounts, and to ensure the proper forms are completed or filed, such as a W-2 or a 1099.
Under the IRS framework, one is considered an employee on the basis of a twenty factor test. This test is complex and is applied on a case by case basis. No one factor is determinative, which creates the difficulty in the analysis because some of the criteria may apply in one case but not in another. Under the twenty factor test, an individual will be considered an "employee" to the extent that you:
- 1. Provide them with instructions;
2. Provide training;
3. Have a continuing, working relationship with them;
4. Establish their work hours;
5. Provide them with full-time work;
6. Provide the work premises which is usually the principal work site;
7. Establish the sequence for the work to be done;
8. Pay the individual at regular intervals;
9. Reimburse business and travel expenses;
10. Supply the tools and equipment to perform the job; and
11. Have the ability to terminate the individual.
Also, the IRS will look to see if the individual:
- 12. Provides services that are integrated into the business;
13. Personally renders the services to your business;
14. Has set hours of work;
15. Has the ability to hire, supervise and pay assistants for the employer;
16. Submits regular reports to the employer;
17. Does not make a profit or suffer a loss from performing the work;
18. Works exclusively, full-time for one employer;
19. Does not offer services to the general public; and
20. May terminate the relationship at any time without liability.
While the IRS test is not the only test, it is the most comprehensive and widely used. However, you need to be aware that ERISA and the NLRA have their own tests.
Regardless of what test is to be applied, it may be easier to prove that an individual is operating as an independent contractor if you:
- 1. Obtain the necessary information up front and maintain proper records;
- 2. Ask any independent contractor for insurance records and keep a copy of their contract or
receipts among other documentation;
- 3. Review your contracts with independent contractors, make sure that the contracts are not old,
and that the job they are performing is not one of your core business responsibilities;
- 4. Keep all receipts to show that you are being billed on a consistent basis with the contract;
- 5. Obtain copies of the business organization records of the independent contractor; and
- 6. Obtain copies of the independent contractor's insurance.
The key is to have the records available that establish to the government that you are not the employer that is liable for various taxes and employee benefits.
Recently, there has been some movement in Congress to try to simplify the IRS rule and thus simplify the rules of all of the multi-factor tests. The "Independent Contractor Determination Act of 2001" is an attempt to simplify the above IRS analysis. This bill is designed to amend the Internal Revenue Code to create a safe harbor for determining whether certain individuals are independent contractors or employees.
Under these bills, in order for an individual to be considered an independent contractor, one of two tests will need to be met. Either:
- 1. The individual has a written agreement, demonstrates economic independence such as
the risk of loss, and demonstrates workplace independence such as a home office or use
of the individual's own equipment; or
- 2. The individual has a written agreement, performs services through his or her own
corporation, and provides his or her own benefits instead of receiving them from the
recipient of his or her services.
This test would allow the employer to exercise some direction and control over the independent contractor without jeopardizing the independent contractor status. Also, independent contractor status is very easily proven by documentation such as a contract tied to completion of a task, or proof of insurance. This test would also take most of the discretion from the IRS in determining whether your independent contractor is an employee. This new test could save your company thousands of dollars from a miscalculation of employment status.
For more information about independent contractors and other employment law issues, call Krukowski & Costello, S.C. at (414) 423-1330, or e-mail client services.
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