Protect Your Money-Saving Use of Independent Contractors

Chances are, your construction business hires subcontractors, rather than employees, to perform some of the work. These arrangements obviously save your company a lot of time, money and headaches. Take a look at some of the recordkeeping and financial differences:

With an Employee:

• You must pay the employer's half of FICA, as well as federal unemployment tax (FUTA).
• You are required to withhold federal income tax and the employee's half of Social Security and Medicare (FICA).
• You must issue a W-2 form to the employee and send copies to the IRS.
• Depending on your company's policies and state and federal laws, you must generally provide fringe benefits, such as health insurance, retirement plans, sick days and paid vacations.
• You are generally required to carry workers' compensation insurance.

With an Independent Contractor:

• You generally don't have to withhold taxes from the worker's pay, you don't owe the employer's portion of FICA and FUTA, and you don't have to pay workers' compensation.
• It's easier to engage workers for specific, short-term assignments. You can tailor work crews to fit your slow and busy seasons.
• You must issue the worker a Form 1099-MISC and file copies with the IRS if you pay the person $600 or more during the year.
• You aren't required to provide fringe benefits. Subcontractors are responsible for keeping their own records, paying their own income and self-employment taxes, and providing their own health insurance.
• You can reduce exposure to some types of legal actions, such as wrongful termination lawsuits.

When you compare the two types of workers, hiring subcontractors is a no-brainer. But make sure your independent workers really qualify for this status under law. Your company can pay a heavy price if you treat an employee as an independent contractor without having a "reasonable basis" for doing so. The IRS routinely "reclassifies" contractors as employees and the costs can be devastating for business owners. You can be required to pay a bundle in unpaid federal payroll taxes, interest and penalties.

Caution: There have been a number of highly-publicized lawsuits filed against companies by independent contractors who claimed they were really employees. Disgruntled workers contact the IRS to complain that they are misclassified. There's even a special IRS form workers can fill out to ask for a determination of their status.

So how can you protect your money-saving use of subcontractors? The issue is complicated so consult with your tax advisor, but here's a rule of thumb: Workers are considered contractors if you have little control over the way they get the job done. The more you direct a worker, the more likely the IRS would classify him or her as an employee.

Unfortunately, no single factor determines a worker's legal status. The IRS looks at a number of issues, such as:

• ‍Providing tools. An employer usually gives tools, equipment and work space to employees. In contrast, subcontractors often provide and invest their own money in equipment, tools and facilities.‍
• Offering services to the public. Subcontractors make their services available to the general public and are free to work for two or more businesses.‍
• Setting hours. Employees often have set work schedules, while contractors are allowed some flexibility. (However, the IRS recognizes that some work, by its very nature, must be done at specific times.)‍
• Hiring assistants. Employees don't hire and pay anyone to help them do their jobs. But contractors often hire, supervise, and pay their own assistants.‍
• Getting paid. Employees are generally paid hourly or weekly, while contractors are paid by the job. It's a good idea to require contractors to submit invoices since they provide proof of non-employee status.

To protect your company, it's crucial to have written contracts with outside workers that clarify details of the relationship. Once you draft contracts that treat workers as independent contractors, live up to them. Resist the urge to supervise subcontractors the way you oversee employees.

Make sure to maintain good records. Obviously, you need to keep the worker's taxpayer ID number and other information required by the IRS, but also keep items that help prove the person is self-employed. For example, business cards, a letterhead, invoices and advertisements placed online or in newspapers. A simple listing in the yellow pages of the phone book is sometimes enough to convince an IRS auditor.