I’ve published an audio version of this article at Anchor.fm, as well as the YouTube video above.

As the definition of work changes and becomes more flexible thanks to technology, the bright line between traditional employment vs. a contracting relationship is likely to blur further. Here are some ideas to help you understand the legal distinctions that need to be made.

The IRS has guidelines to help you make the distinction, but even they leave a touch of grey around the edges. Their “topic paragraph” in the IRS article says:

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, not what will be done and how it will be done. Small businesses should consider all evidence of the degree of control and independence in the employer/worker relationship. Whether a worker is an independent contractor or employee depends on the facts in each situation. (bolding added)

If the IRS ever examines your particular situation, the guidelines they will use are:

  • Behavioral Control – “the right to control and direct the worker.”
  • Financial Control – “the right to control the economic aspects of the worker’s job”
  • Type of Relationship – perhaps vaguer than the others, at least on the surface: “facts that show how the worker and business perceive their relationship to each other.” I’ll unpack this a little more later in this article.

In general, businesses tend to push the limits in characterizing individuals as contractors, because it limits costs and the overhead expense of paying and remitting payroll taxes. It also shifts certain burdens to the individual doing the work. We work with companies that employ people remotely, and the costs of providing worker’s compensation, along with payroll taxes from all the local, state, and federal tax authorities involved can be substantial. Additionally, hiring someone in a different state establishes nexus in that state, which may create additional complications and expenses.

I’ll add here that the IRS isn’t the only authority with an interest in this; state wage and hour boards will also take an interest in your hiring practices. But I’ll discuss the IRS in this article because we’re all subject to their regulations in the US.

Unfortunately, the least complicated or expensive option isn’t always the one that keeps you in compliance.

The IRS will apply the tests described above, and if it determines that you’ve hired a de facto employee, the fact that you’ve asserted this individual is a contractor, NOT paid taxes, and NOT provided benefits, will not necessarily help (see “Type of Relationship” link above). It’s better to understand in advance how this works and make sure you avoid a grey area if you can.

Some examples might be helpful to illustrate some or all of these criteria. Remember, you as a business owner may be motivated to hire people as contractors, but the IRS may disagree:

Obviously an Employee – If you hire someone to work for you, provide tools and equipment at your office or on your job sites, tell them to be at a certain place and a certain time to work with other workers that you’ve organized to do a job, and pay them while you collect from the customer, these people are clearly your employees. This may seem so obvious that it isn’t worth mentioning, but I’ve heard of two different lawn services recently which offered “jobs” to people on a 1099 basis.

Clearly a Contractor – If you hire a professional or consultant to perform a job for a limited time, you’re generally in the clear. If you hire an attorney to look at your sales contracts, a CPA to do your books, or a consultant (like me!) to train people, set up QuickBooks Online, or configure some other software for you, you will be fine. An informal litmus test that’s often mentioned is “does this person provide these services for others?” If so, you’re more than likely okay. Also, don’t be afraid to check if your contractor is licensed as applicableWhile this factor alone does not provide iron-clad protection, the lack of licensing (business, trade, professional, etc.) may expose you to several risks (and not just the risk they’ll be seen as an employee by the IRS). While it’s not directly applicable to this topic, I’ll also mention that asking for proof of insurance is a good idea as well.

More complicated scenarios – There are many situations that will require careful judgment. I’ll offer a few common scenarios:

  • subcontracting. In the lawn service scenario I mentioned above, the problem is that a company was hiring individuals. But if a lawn company wanted to get some help, or needed a specialized service that they don’t do (for example, laying new sod or planting trees), it would be fine to contract with another company to do the work. This second company would be responsible for licensing, insurance, and properly paying their workers (but the prime contractor should do some due diligence to make sure that’s happening). This would also hold true for IT contracting and many other kinds of work.
  • long-term retainers. As Nectar Bridge offers services in this category, I’m particularly keen to avoid problems in this area. It’s more clear-cut under “Type of Arrangement” as described above if a relationship is short-term, with a definite beginning and end in mind. But some processes do continue indefinitely, and you can work with a contractor on this basis. But be careful to avoid having it turn into a relationship which the IRS views as employment that should have been done on a W-2 basis. The contractor should perform work on their own schedule, with their own equipment, and be doing it for others in addition to yourself, at minimum. Again, due diligence to make sure your contractor is licensed and organized properly as a business is a good idea for more reasons than one.
  • remote work. I include this here mainly because some employers feel that all remote workers can be contractors. Some large, prominent companies have lost some legal battles here. It’s not enough to say that the worker uses their own equipment and a home office (or that they’re mobile); if you require them to keep specific hours while controlling and directing their work, you can’t consider them contractors.
  • commissioned salespeople. Salespeople on straight commission (i.e. they only get paid if a sale comes through) can be contractors, running their own business. It’s not uncommon for independent representatives to sell for multiple companies this way. But as with the other scenarios, it’s all too easy to get in trouble. You’ll need to be careful to keep independent representatives independent.

Please note that this advice is general and is not intended to diagnose your particular situation. Contact us if you have questions.


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