Tell IRS Whether You Are An Independent Contractor Or Employer

James L. Silvester

One of the most expensive aspects of entrepreneurship is your staff.

If you are very successful at your enterprise, you may find the need to hire additional help to facilitate the growth of the business. Then you face the choice of paying people as "independent contractors" or as "employees." The differences can be very large and pose a few financial risks.

Your instinctive reaction is going to be to pay people as independent contractors and report their earnings on IRS Form 1099. You might be saving some dollars because you don't have to pay their social security taxes, workers compensation insurance premiums, unemployment insurance, and the expense of collecting, forwarding, and accounting for federal and state tax withholding.

Be aware the Internal Revenue Service requires that a person must meet certain requirements before declared an independent contractor. You can not impose regular hours, force them to be in your office, or manage them in the traditional sense of the word. And the tax penalties are very stiff if you pay someone as an independent contractor and the IRS later determines they should have been declared employees. You could be held responsible for their taxes if they failed to pay their 1099 earnings not to mention the assessment of additional fines and penalties.

Now I am not trying to scare you because many people can qualify as independent contractors such as free-lance consultants, web designers, work-for-hire writers, etc. There are general categories widely accepted by the IRS.

It is always safe to pay people as employees and the expenses are all deductible just like independent contractor expenses. You will have to pay 50 percent of their social security taxes, pay workers compensation insurance, and pay unemployment insurance premiums. All in all it will add a 15 to 20 percent cost burden over paying these people as independent contractors.

However, you do have peace of mind the IRS will not knock you over the head at some point. And you are insulated from an independent contractor later saying they deserve unemployment benefits when he or she can't negotiate a future contract and thus have no income. It happens more often than you think. In addition, consider if the independent contractor is injured while doing work for you and you have no worker's compensation insurance.

If it goes to a lawsuit and the court determines that the independent contractor should have been declared an employee, you are at risk. With no workers compensation insurance, it now becomes a criminal issue against you.

Give it careful consideration and check with your CPA.

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