Contract vs. Employees: What You Need to Know
Andres Rodriguez | Dreamstime.com
Our evolving economy has developed quite a few new wrinkles over past decades. We don’t make as much stuff as we used to; rather, we’ve evolved into more of a service-based economy. Far less information is delivering via a piece of paper. Today, the glowing rectangle in front of us delivers most of the data we need.
And not only are workers less likely to stay with one company for the long haul, they’re also far less likely to be on a company’s payroll.
These days, tens of millions of workers exist as independent contractors rather than as employees. They are lawyers, yoga instructors, cable TV installers and writers. They pay their own taxes and secure health insurance independently. But in many cases, they shouldn’t have to.
Certainly, many contractors made a conscious choice to strike out on their own, preferring the freedom and the variety of work that accompanies that decision. But a great many freelancers would be much happier as an employee and essentially function as such. But the companies they work for often prefer to keep their payroll lean so they can adjust to fluctuating business climates without the mess of layoffs. The bottom line is that freelancers are cheaper. But they aren’t always legal.
“Companies don’t want to pay the benefits,” said Joy Child, a tax partner with Alexander, Aronson, Finning & Co. in Westborough, Mass.
Small businesses generate a large share of new jobs as they find success and expand. And while it might be tempting to work with a staff of freelancers rather than a payroll, there are consequences for misclassification.
“Penalties are so high,” said Child, explaining that a company wrongly treating its workforce as independent could be liable for payroll taxes, interest and penalties. Child said the IRS and state governments look for clues that a company might be shirking its responsibility. “If there were lots of 1099s issued and very little payroll, that would indicate that there might be a problem,” she said.
Years ago, Microsoft ran afoul of tax rules, classifying thousands of programmers and computer engineers as freelancers, but the government ruled otherwise. As a result, Microsoft was required to pay millions of dollars in penalties, and the case yielded a set of guidelines that employers can use to determine whether a worker is an employee or an independent contractor.
Control over how work is done
Workers who work when they want to, where they want to, using methodologies or guidelines that they determine, are rightly considered to be independent contractors. If, however, a company tells workers they have to be in the office for a fixed period of time and work according to company specs, those people may be employees.
Equipment and software
Does the worker use his or her own computer? Or do they use a machine on site? Does that machine have software on it that the worker does not have? Do they use company office supplies? If those facts tie the worker to the company, then she could be an employee.
Freelancers should generally be paid by the job. If a company pays a worker a monthly or yearly amount, the IRS will likely categorize that person as an employee. Remember, businesses need to send all independent contractors a 1099 , reporting how much the company paid the person over the course of a year.
Businesses shouldn’t have to train independent contractors, according to the IRS and many state labor boards. Independent contractors should be able to begin immediately, producing work that they’ve been hired for. If a worker requires significant training, they may be considered employees.
Freelancers run a business
True freelancers often have desk space, business cards and letterhead. They may advertise their services to other companies. Additionally, they often have the option of subcontracting work. To the extent that a company’s workers don’t (or can’t) do that, those circumstances may push workers closer to being employees.
Companies should make sure to have workers sign a work-for-hire contract. Such a document doesn’t guarantee that the worker will be considered independent, but it is certainly likely to help.
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