We often hear business owners, especially small businesses, ask “what is an independent contractor?” This is an excellent question as it can have far-reaching tax implications. A wrong classification can lead to rather severe tax penalties. One thing to remember is that an independent contractor is not considered an employee. While they may be compensated for work that they perform for individuals and businesses, the relationship between them should be well defined.
While this may be handled by oral arrangement, having it written out and signed by all parties can help to avoid any legal questions about expected duties and responsibilities for each. It should help to define any required standards for the work and should also establish the rate of pay for said work. Independent contractors do have a great deal more freedom in their work including the ability to choose a range of businesses with whom they can contract. At the same time, they sacrifice many of the legal protections held by employees.
Independent Contractor – Duties and Rights
When it comes to hiring an independent contractor (IC), you are not the employee. Rather, you are the customer. The IC maintains the right to complete a given project when, where, and how they wish. You do not retain the right to direct the independent contractor’s work. While you can specify the outcome of the job awarded to the IC, they maintain the freedom to choose how to get to that outcome.
Just because you cannot oversee the job directly, it doesn’t mean that the IC has complete control over all parts of the contract. Independent contractors must be able to complete projects in the quoted timeline and to any specifications set forth in the IC agreement. They are also responsible for their own tax payments. Where you would normally pull withhold taxes for employees, the IC has the duty to do so for themselves.
Definition of an Independent Contractor
Per federal law, workers fall into one of two categories. Either they qualify as an employee or as an independent contractor. The determination of this classification depends upon the amount of control the employer has over the IC, versus the amount of independence the independent contractor retains.
When it comes to one hard and fast rule that will help you determine whether you are hiring an independent contractor or an employee, it simply doesn’t exist. It takes looking at the whole situation to help make the determination. There are several factors that may influence the outcome of the determination including:
- How permanent is the business relationship?
- Is the individual providing services integral to the businesses operations or offerings?
- How much control does each party retain, and what is the nature of said control?
- How much is the worker investing in materials and/or equipment?
- What sort of opportunities for profit and loss does the worker experience?
- How independent is the worker when it comes to operations and business organization?
There are other factors that may seem relevant but are not. Such factors can include the method and timing of payments, whether a formal signed agreement exists, and whether the individual is licensed by state or local governments.
If you find that you are unsure whether your current agreement and arrangements with an independent contractor have been handled correctly, please be sure to contact us today. We are always happy to help with any questions that might arise.