This is a two part blog post to help you identify a true independent contractor versus an employee and how to pay them.
In order to know how to pay staff for their services, you must first understand what their classification is. One of the things you need to know is what business relationship exists between you and the person performing services for your company.
Here’s a highlight of the different classifications:
An employee (common-law employee)
- Under common-law rules, anyone who performs services for you is your employee if you can control what will be done and how it will be done. This is so even when you give the employee freedom of action. What matters is that you have the right to control the details of how the services are performed.
An independent contractor
People such as doctors, dentists, veterinarians, lawyers, and contractors who are in an independent trade, business, or profession in which they offer their services to the general public are generally independent contractors.
The general rule is that an individual is an independent contractor if the payer has the right to control or direct only the result of the work and not what will be done and how it will be done.
A statutory employee
If workers are independent contractors under the common law rules, such workers may nevertheless be treated as employees by statute (statutory employees) for certain employment tax purposes if they fall within any one of the following four categories:
- A driver who distributes beverages (other than milk) or meat, vegetable, fruit, or bakery products; or who picks up and delivers laundry or dry cleaning.
- A full-time life insurance sales agent.
- An individual who works at home on materials or goods that you supply and that must be returned to you.
- A full-time traveling or city salesperson who works on your behalf and turns in orders to you from wholesalers, retailers, contractors, or operators of hotels, restaurants, or other similar establishments.
A statutory NON-EMPLOYEE
- There are three categories of statutory non-employees: direct sellers, licensed real estate agents and certain companion sitters, that's it.
A government worker-enough said.
More about independent contractors:
The advantages to an employer to hire independent contractors instead of employees are large.
- Reduced overhead costs
- Reduced payroll taxes, and
- Reduced expenses of paying an accountant for such payroll.
There are no benefits for the staff member you hire as an independent contractor.
- No health insurance, no vacation, no jury duty, no time off with pay. That means that the independent contractor works when the employer wants him to.
- There is full flexibility about when they work with no overtime pay for long hours and no pay for down times.
- In addition, you can many times get very experienced and well-trained contractors if you were hiring employees the employer would be responsible for getting them trained up.
From the IRS point of view…
Independent contractors have a much easier time if they choose to cheat on their taxes. The IRS does not like independent contractors and is beginning to look more closely at industries - including the salon and spa industry - to audit and potentially penalize businesses who have them miss-classified.
So what makes one person an Independent Contractor and another an Employee?
As much as it might be a matter of choice it really is not. The government won’t let you just choose.
In 1987 the IRS created a list of 20 factors they consider relevant in determining a worker’s employment status after examining the case law. The amount of weight given to each of the twenty factors depends on the job and the actual situation that the worker operates in.
- Instructions: If the employer has the right to require the worker to comply with the employer's instructions.
- Training: If the worker can be required to attend training as to how the work is done.
- Integration: Are the services performed by the work integrated into the normal operations of the business.
- Personal Service: Does the employer require that the worker performs the services or can the worker at their own behest substitute another person.
- Hiring, Supervising, and Paying: If the employer hires, pays, and supervises assistants for the worker rather than the worker hiring, paying and supervising his or her own assistants. This is an indication of control.
- Continuing Relationship: That the employer and the worker maintain an ongoing and continuous relationship.
- Set Hours of Work: The worker has established regular hours for work set by the employer.
- Full-time Required: The worker should work full time for the employer rather than be free to work for whoever they want to and whenever they want to.
- Work on Employer’s Premises: The services performed by the worker are performed in facilities controlled by the employer.
- Sequence Test: The worker performs tasks in the order that the employer specifics.
- Reporting: The worker must submit reports either verbally or in writing on a regular basis.
- Payment: The work is paid by a time unit (Hour/day/week/etc.) as opposed to being paid by the job.
- Expenses: If the employer pays the expenses for the worker it leans toward an employment status.
- Tools: Normally if the workers' tools are provided this would indicate that the worker is an employee.
- Investment: If the worker has made a significant investment in the facilities where the work is performed it indicates that the worker may be an independent contractor.
- Profit or Loss: A worker who is an employee does not normally make a profit or a loss in addition to his normal pay.
- One Employer: Normally a worker who performs the same service for multiple employers at the same time is indicative of an independent contractor.
- Generally Available: If the worker makes his services available to the general public it is indicative of an independent contractor.
- Discharge: The ability of an employer to fire a worker leans toward the worker being an employee.
- Termination: A worker who can quit at any time indicates that the worker is an employee.
An example (Salon Owner)
You bring in a booth renter to your salon. A booth renter is also known as an independent contractor (did you know that?). You offer them to use your business cards to promote your business to their clients. You tell them that they can bring clients into the business during the hours that you have created for your business. You offer them to use your supplies as part of their rent. You get into an argument with the booth renter and terminate the contract. The booth renter files for unemployment, knowing that they should not as they are not an “employee”. She tells the unemployment office that you gave her business cards and all the supplies needed to do the job. Guess what? The unemployment office will consider her an employee, will approve unemployment benefits, and your business could be flagged to be audited. Sound crazy? Yes, but happens.
When deciding whether your new hire is an independent contractor or an employee consider what could happen when your ex-employee files for unemployment. Cover your bases and be sure to manage each type of employee the correct way.
Coming next month? Part 2: How to pay them...
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