There are numerous reasons why business owners choose to outsource work to independent contractors. Freelancers are generally cheaper then employees since the employer is free from paying unemployment insurance, worker’s compensation insurance, and payroll taxes as well as a slew of other benefits or perks. Hiring an independent contractor also offers employers a measure of flexibility since employers don’t have to keep contractors on the payroll when business is slow, and there are few regulations regarding their termination.
Given all these advantages, business owners might be tempted to give some permanent employees a consultant or freelance status. But beware: business owners who take on many suspicious “freelancers” increase their risk of an audit by the IRS or the state labor department to see if they fudged their employees’ status.
In order to avoid such scrutiny, business owners should be clear about what constitutes an independent contractor versus an employee. According to the IRS, the definition of an independent contractor follows several general guidelines, or “Common Law Rules.”
Generally, the IRS is concerned about the level of control the independent contractor retains. The IRS will specifically examine three areas, behavioral, financial, and relationship, when determining if a particular worker is indeed a freelancer:
- Behavioral: Who determines how the assignments are performed? Who determines the worker’s schedule? At which location does the work occur? Ideally, an independent contractor or consultant should have control over when, where, and how the work is done. If the business owner controls those areas, that worker is an employee, not a consultant.
- Financial Control: Does the firm reimburse all of the consultant’s expenses? How is payment determined? Who provides supplies and equipment? A true independent contractor should be self-employed, and own the equipment necessary to perform the work. Usually, not all of a contractor’s expenses are reimbursed. Generally, an independent contractor is paid a flat fee for a job, rather than a fixed hourly or weekly rate. Someone who requires the business’ equipment to perform all his/her work tasks is an employee.
- Type of Relationship: Does the worker receive benefits? Will the worker’s relationship with the business continue indefinitely? Does the firm represent the worker to customers as an employee? An independent contractor should be able to work for other clients simultaneously. The independent contractor performs a particular job, and is responsible to complete it. He or she should not be tied to the business as is an employee.
In short, business owners can’t assume that just because they don’t pay benefits, the worker is necessarily a consultant. If the work performed is a key aspect of the business, and the worker is exclusive to that business, he or she is an employee.