It is a $65,000 test. Can you pass it? Nine out of ten IRS audits result in the reclassification of independent contractors to employees. The average penalty exceeds $65,000. Guess who the targets of such audits are? That's right, small businesses. (Remember a small business is any business with less than $1 million in revenue.)
The IRS uses a list of criteria to determine whether someone is an employee or an independent contractor. One item alone isn't enough to prove or disprove classification. The IRS looks at all 20 items as a whole. But keep in mind the IRS makes more money from an employee than an independent contractor. That revenue is always on their minds.
Employee Criteria
1. Direction you have control over when and how something gets done.
2. Training teaching someone how you want the job done.
3. Success the services performed are necessary to the success and/or continuation of your business.
4. Personal Services you specify the person who must accomplish the task or perform the service.
5. Supervisor the person is responsible for hiring and supervising assistants under your direction and approval.
6. Ongoing Association the person continues to work for you.
7. Hours the person is required to work set hours or a specified number of hours.
8. Full-Time the person works full-time for you.
9. On-Site the person works at your location or a location you designate.
10. Set Order you prescribe a schedule or order to the person's tasks.
11. Reporting you require regular oral or written reports.
12. Salary you pay by the hour, week or month.
13. Reimbursements you reimburse the individual for business expenses.
14. Equipment you furnish the tools and equipment needed to perform the job.
15. Facilities you furnish the place in which to work.
16. Monetary Gain the person is restricted in the amount he/she can earn as well as protected from losses incurred by the business.
17. More than One the person works for you and only you.
18. General Public the person doesn't advertise or otherwise offer his/her services to the public at large.
19. Dismissal you have the right to let a person go at will.
20. Quit the person has the right to quit at any time.
Independent Contractor (IC) Criteria
1. Direction the IC decides how and when to get the task done.
2. Training he/she has the skills and experience to get the job done when contracted.
3. Success the reputation of the person or the person's company is affected by the service or product.
4. Personal Services the IC uses assistants or subcontractors to complete the task with or without your knowledge.
5. Supervisor he/she hires and supervises assistants without your direction or input.
6. Ongoing Association the association ends when the project is complete. However, can be hired to complete additional projects.
7. Hours the IC works when he/she wants to as long as the deadline for the project is met.
8. Full-Time an IC is able to work when he/she chooses.
9. On-Site works at his/her own location.
10. Set Order he/she decides how to work as well as the order the tasks are completed.
11. Reporting the IC can be required to file progress reports but shouldn't be required to provide reports reviewing his/her work.
12. Salary you pay on a commission or project basis.
13. Reimbursements business expenses are part of the project cost.
14. Equipment the IC has his/her own equipment and materials.
15. Facilities the IC has his/her own place of business. The IRS requires the facilities to be real, essential and adequate.
16. Monetary Gain the person has the possibility of profit and/or loss as well as capital invested in the business.
17. More than One the person not only works for you but others as well.
18. General Public the IC advertises and actively markets his/her services to the public at large.
19. Dismissal you can't discharge an IC as long as he/she is meeting the deadlines and criteria set forth in the contract.
20. Quit an IC can't quit until the job is complete or he/she is obligated to compensate you based on the contract.
Basically it comes down to control. If you control the workflow, order, hours and outcomes, you are an employer. It should also be noted that if you hire someone as an employee, he/she quits and you hire them back as an independent contractor doing the same type of tasks or projects, the IRS will reclassify this person as an employee.
Consequences
Like I said earlier, the IRS likes the revenue aspect of a business having employees. If you have an IC that is reclassified as an employee, you (your company) will be responsible for all withholding including state and federal income tax, Medicare, social security, unemployment, worker's compensation and penalties. That means the new employee gets to keep everything you have paid him/her and you foot the tax bill.
Do you pass the test?
If you would like additional information about employees and independent contractors, please email (suzette@flemmingbusinessservices.com), Skype us (Suzette4fbs) or call us (406-788-5227). We would be delighted to help you.
