An independent contractor is a legal category or job description recognized by the Internal Revenue Service and refers to the obligations of an individual to the IRS and the company, and the obligations of the company to the IRS for IC’s.
Question: A company wants me to work for them as an independent contractor. What are the implications of being classified an independent contractor? What
are my obligations and needs, and what are my options?
Answer: An independent contractor is a legal category or job description recognized by the Internal Revenue Service and refers to the obligations of an individual to the IRS and the company, and the obligations of the company to the IRS for ICs. In effect, being an IC makes someone a company doing contract work for other companies.
Maybe the most important issues involve workers’ compensation coverage, employee income-tax payments to the government, and the employer’s half of the Social Security and Medicare payments to the government. All companies are required to have workers’ compensation coverage for all its payroll employees. An IC is not an employee — thus is responsible for their own workers’ compensation.
A company is obligated to deduct from the employee’s wages and pay to the governments, on a timely basis, all income taxes.
On the other hand, an IC must make those payments directly to the IRS.
Normally for Social Security payments to the IRS, the company pays half and the rest
is deducted from the employee’s earnings. As an IC that “employee” is responsible for paying both halves out of their earnings directly to the IRS.
As you can see, there are advantages to the company to hire ICs rather than employees. Conversely, it gives the IC greater independence. To audit this relationship, the IRS has a set of 20 test questions to clarify the relationship. These parameters apply:
1. You or your employees instruct the individual in how, when, where and whether the work should be done.
2. You must train the worker before the job is undertaken.
3. The individual becomes substantially a part of your company operation.
4. The worker must personally perform the work rather than have it done by his or her employees.
5. The worker does not have employees.
6. Your company has a continuing relationship with the worker.
7. You tell him or her what hours of work to follow.
8. He or she works virtually full time for you.
9. All the work is done on your premises.
10. He or she does not control the sequence of events to follow.
11. You require frequent significant progress reports.
12. You pay on the basis of time put in, rather than type of work done.
13. You reimburse for costs not covered by the contract.
14. You furnish the tools and equipment.
15. He or she has no significant investment in his/her own business.
16. He or she will realize neither profit nor loss from the job.
17. He or she works only for you.
18. He or she does not offer services to the general public,
19. You can discharge the individual.
20. He or she can terminate the relationship without penalty.
Although a single factor from among these 20 can be determinative, generally it’s a combination of two or more factors that determines whether a worker is an employee or an IC. In applying such questions, the IRS obviously would rather collect from a company all the employee’s income-tax contributions than collect from hundreds of independent contractors. It just makes the collection easier.
Therefore you should examine the company’s requirements and practices involved in doing the job and make sure that that the relationship is really at “arm’s length” to avoid the penalties that the IRS can level in cases of fraudulent declaration of IC status.
To discuss qualifications of an independent contractor, please call for a free, confidential appointment with an experienced SCORE counselor at 815-544-4357 in Belvidere or 815-962-0122 in Rockford.
Ted Cowen is a counselor for Northern Illinois SCORE, a volunteer organization that offers free, confidential mentoring, coaching and counseling to businesses, and low-cost workshops to entrepreneurs and small-business owners. E-mail info@NorthernIllinoisSCORE.org or go to NorthernIllinoisSCORE.org on the Web. Send questions to SCORE, 200 S. State St., Belvidere, IL 61008.