Are You Really An Independent Contractor?

Raise your hand if you’re an independent contractor. Good. That’s a significant number of my readers.

Now raise your hand if you think that your clients are working within the law. Hmmm…I thought so. Some of you who raised your hands with the first question didn’t raise them again.

Oh, only if I could really see what everyone’s response is when they read this article….

What Are You?

Seriously, the problem of independent contractor versus employee classification is a significant one, an issue that looms large with at least one government agency – the Internal Revenue Service (IRS). The IRS, like so many taxing authorities in the western world, has been looking at this issue for many years, especially since the mid-1990s when online internet access began its surge and more people started to make money online.

Today, millions of Americans make at least some of their money online, usually small amounts by selling something on eBay, or by featuring a service on Craigslist, or in picking up a gig or two on a freelancing site, and the like.

Then, there are people like myself whose entire livelihood is cyber-connected, meaning that we interact with clients online, sell advertising, and use other forms of work to get by.

No Benefits, Just Work

In a down economy, which is exactly where we find ourselves today, many employers have cut back on staff only to replace some of their workers with independent contractors. The advantage to employers is obvious: loosen up the relationship you have with certain key people and you don’t have to pay benefits.

Social security, disability, unemployment insurance as well as your personal health, dental, life, and retirement benefits no longer apply. The employer is now a client, while the employee is now a business partner. But that relationship isn’t always so clear.

The IRS has one good reason to warn everyone that some independent contractor relationships are in violation of the law: government coffers are running low. In a tough economy this problem is magnified as higher unemployment means fewer tax dollars. And with the federal government running at debt levels never before seen, the IRS will be looking at extracting funds wherever possible.

Test Your Relationships

As a freelancer, you should employ the same tests that the IRS uses to determine your relationship with your clients. The operative word here is relationship which means that there are three characteristics the IRS looks at: behavioral control, financial control, and the type of relationship. Each of the quoted descriptions following have been taken directly from the IRS website; my comments follow:

Behavioral Control – “Does the company control or have the right to control what the worker does and how the worker does his or her job?” Many of us are in gray area territory here. If you blog for someone do they come up with specific subjects, titles, links, and a schedule that you must follow? If so, the client may have crossed a line somewhere. Familiarize yourself with IRS guidelines regarding independent contractors.

Financial Control – “Are the business aspects of the worker’s job controlled by the payer? (these include things like how worker is paid, whether expenses are reimbursed, who provides tools/supplies, etc.) ” Regular and steady payments from one party to the other could signal to the IRS that some more than a freelancing arrangement exists here. Ask your accountant if it appears that one or more clients exerts financial control.

Type of Relationship – “Are there written contracts or employee type benefits (i.e. pension plan, insurance, vacation pay, etc.)? Will the relationship continue and is the work performed a key aspect of the business?” Top clients care about their contractors and sometimes extend special privileges (benefits) to them. Those benefits, however, might be taxable and could recast your entire relationship with them. Tell your accountant about any sort of “side benefits” offered with your gigs.

Substantial Tax Bills

If the IRS discovers that you are, indeed, an employee then your client is actually your employer which means that they can “end up with substantial tax bills.” Moreover, they could be saddled with penalties for not paying employment taxes as well as for failing to file the required forms. Workers can recoup lost benefits and trim their tax bills accordingly.

I’m not sharing this information with you in order to strike fear into your heart. You work hard and you pay your taxes, but certain relationships may be in violation of the law.

Either you or your client may ask the IRS to make a determination regarding your relationship by filing Form SS-8 – Determination of Worker Status for Purposes of Federal Employment Taxes and Income Tax Withholding – with the IRS. The IRS says that this determination can take as long as six months, therefore be prepared for the worst, but hope for the best.

Yes, I know what you’re thinking: taking this step could open up a fresh can of worms for you. Then again, if you strongly believe that your business relationship violates IRS guidelines, don’t think for a moment that you’ll never be found out.

1099-Misc Forms

If you believe that your relationships with your clients passes IRS tests, then make sure that you have all of your 1099-MISC forms in your possession when you file your taxes next year. You may have been performing work without these forms under certain circumstances, but if your income exceeds $600 with any one client, then insist on getting this form from them before January draws to a close.

Visit www.irs.gov to review related publications as well as to download a copy of the form.

Resources

Internal Revenue Service: Employee vs. Independent Contractor — Ten Tips For Business Owners

Los Angeles Times: Get jump start on next year

The Wall Street Journal: The Ins and Outs of Hiring an Independent Contractor

Photo Credit: IRS