Updated: Sep 25
Contractors and employees have a lot in common. They perform work that’s asked of them for compensation, companies give them access to their networks and other IT assets, and they’re both expected to meet standards of conduct set by the company. But at the end of the day, they’re not the same thing, and when you treat a contractor like an employee, you open your company to potentially serious liabilities.
The Hazard of Misclassification:
There are a lot of things that happen when you misclassify an employee as a contractor. You’ll have to reimburse Social Security, Medicare, and unemployment for any premiums that weren’t paid. You may also face substantial fines and you can look forward to periodic audits of your employee records for the foreseeable future. In addition, you may have to reimburse your health and worker’s compensation insurance providers and pay any fines that they assign for misclassifying an employee as a contractor.
The Three IRS Tests:
Because the penalties for misclassifying employees as contractors are so serious, the IRS has provided three rules they use to determine whether someone is an independent contractor or employee.
1. Behavioral Control
As a client, your company defines what work has to be completed, and when. It’s largely up to the independent contractor how the work is performed. This is unlike an employee, whose work is directed by a manager. To make sure that a contractor isn’t confused for an employee, your company needs to take a “hands-off” policy towards the work, and not be too involved in the process.
2. Financial Control
Independent contractors are paid for the work they complete. They aren’t reimbursed for such things as office supplies and necessary travel. They don’t have sick time or vacation time, and they’re responsible for all taxes, including Social Security and Medicare.
An independent contractor performs work within a well-defined business relationship with a clear starting point and an endpoint. An employee is considered to be employed until they’re officially terminated.
Following the IRS rules is a great way to make sure you don’t misclassify an employee. Here are some strategies to remain in compliance.
Get it in Writing
Just because you have a good working relationship with your contractor doesn’t mean that they will never be mistaken as an employee. A written contract can make everything clear and keeps everyone on the same page.
Remember, an independent contractor is supposed to be independent
One of the quickest ways to muddy a working relationship with your contractor is to use too much oversight. They’ve agreed to meet your requirements, let them do so, however, and wherever, they want. That means that you shouldn’t expect them to report to your office on a regular basis.
Don’t Treat Them as Permanent
Your contractor provided what you needed when you needed it, and you’re very happy. It’s been a successful contract. Does that mean your business relationship with the contractor has to end? Not necessarily. However, the engagement itself should end. Every contract you write should have a well-defined period of engagement, including dates of deliverables and expiration date. If you want more work out of the contractor you should create a new contract.
Use an Employer of Record
One of the best ways to avoid any confusion on a contractor’s status is to use an Employer of Record. By using an Employer of Record, there’s no room for confusion or doubt about the status of a contractor. An Employer of Record assumes all the risks and liabilities that your company would have when working with a contractor. They also manage the relationship with the contractor, helping you to negotiate any misunderstandings and smoothing the conflicts that often arise during the normal course of business.
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