Freelance Part 2: The Legal Aspects of Independent Contractors

The pros and cons of hiring independent contractors were discussed in the Pros and Cons of Hiring Freelancers. Today we will look at the legal aspects of employing this type of worker.

• Viola Joyner @ photoXpress.com

The biggest issue with using freelancers is that it puts the government and the employer at odds. Both are looking for ways to impact their bottom line. The government wants the taxes associated with traditional employees and the company wants to avoid paying those taxes. In this case, more money in the employer’s pocket means less in Uncle Sam’s. It is important to be aware of how the government classifies independent workers.

Different agencies give varying verbiage outlining the definition of an independent contractor, but they all provide the same basic guidelines. It is important to avoid giving the IRS, or any other agency, any reason to conduct an audit. Understanding the following guidelines is key in ensuring that all freelancers remain classified that way.

An Independent Contractor…

--May earn either a profit or a loss from a job

--Uses their own tools and/or materials

--Is paid by the job or project

--Is hired to do a specific job or project

--Has multiple employers, or clients

--Pays their own expenses

--Sets their own hours

--Works on their own, with little training or management

--Completes jobs by their own means to achieve the desired end result

--Maintains their own work space

--Has a contract with the client

An Employee…

--Can be fired at any time and has the right to quit without liability

--Is paid by the hour or receives a salary

--Receives instruction and training

--Works full time

--Is managed closely and has a set way to complete the job

--Receives benefits such as worker’s compensation, health benefits, and   unemployment.

Again, there is not a strict set of rules that separates independent contractors from traditional employees. The Department of Labor states that it “depends upon circumstances of the whole activity.”

Being audited and found to have misclassified workers can cripple a company financially. The IRS assesses for payroll taxes plus interest, but can also recoup for the employee’s portion of the income taxes plus interest. The employee that was misclassified can also file paperwork for “Uncollected Social Security and Medicare Tax on Wages.” Add in all the fees, lost time, and loss of productivity resulting from the audit, and the total bill will be in the thousands.

Red flags that the IRS watch  for include an independent contractor that tries to collect unemployment, file worker’s compensation, or files their own taxes wrong. Obtaining a 1099 from the freelancer for tax purposes and being very clear that they are not eligible for any employee benefits is important.

The classification of any independent contractor should be discussed with your attorney. Assigning the proper designation at the onset of employment, while perhaps slightly more costly in wages or benefits, is imperative for the health of the company.

Sources:

Independent Contractor (Self Employed) or Employee? (January 10, 2013) IRS.  Retrieved on March 31, 2013 from http://www.irs.gov/Businesses/Small-Businesses-&-Self-Employed/Independent-Contractor-(Self-Employed)-or-Employee%3F

Small Business/Self Employed: When IRS Trouble Comes. (n.d.) Tax Law. Retrieved on March 31, 2013 from http://www.taxattorneydaily.com/topics/ch-11-small-business-self-employed.php