There has been a dramatic increase in the number of small enterprises that rely on freelancers and consultants instead of full- or part-time workers. However, employers need to know the ins and outs of the independent contractor categorization to comply with U.S. Department of Labor (DOL) and Internal Revenue Service (IRS) rules before entering into an independent contractor arrangement with a worker.
What is an Independent Contractor?
A company or individual that provides services for a third party is considered an independent contractor. A contract is signed between the two parties outlining the contractor’s responsibilities, payment, the scope of work, and other terms. Businesses frequently use Independent contractors as a cost-effective alternative to hiring new employees to fill temporary roles.
How Do Employees and Independent Contractors Differ?
DOL: When deciding if someone is an independent contractor, the Department of Labour looks at the type of work and how much control the person has over it. It also looks at the worker’s chances of making or losing money, how long the relationship will last, and more.
IRS: The IRS considers a person to be an independent contractor if the person paying them only has control over the results of the work, not necessarily how it is done. An independent contractor fills out the IRS Form W-9, and the IRS Form W-4 is filled out by an employee.
Previously, the IRS employed a 20-factor test to assist businesses in determining whether someone was an independent contractor or employee. However, it has now compressed these into three categories.
Relationship of the parties: Does the company offer any benefits? Is the work arrangement governed by formal contracts or oral agreements?
Financial control: Is the business in charge of the financial aspects of the worker’s job?
Behavioral authority: Can management determine which tasks get completed and how they’re completed?
Examples of Independent Contractors
Some examples of independent contractors include:
- Freelance writers and graphic designers
- Real estate agents
- IT professionals
Advantages of Using Independent Contractors
Lower overhead since the contractor is responsible for the overhead costs
Independent contractors are often experts with a specialized skill set in their area
When the project is finished, you can opt to offer another project to the independent contractor or not
Disadvantages of Using Independent Contractors
They may not be available when you need them
Unless specified in the contract, any work the contractor does on your behalf may not be legally your property
You may be subject to an audit by the IRS, the DOL, or another regulatory agency if they determine that contractor more accurately fits the employee definition
Bottom Line
Hiring an independent contractor can save money when a company has one-time needs or wants to get something done that a regular employee can’t. An independent contractor can be a great asset to your team if you pay them properly and follow all applicable regulations set forth by the IRS and the Department of Labor.