Bringing on a self-employed contractor, instead of adding to direct employee headcount, can save a small business owner as much as 30 percent (per worker) in additional payroll taxes and benefits. It also introduces flexibility in hiring and firing, and can reduce strains on office space, training budgets, and more.

It all sounds fairly straightforward. However, in legal terms, the line between an independent contractor and an employee is not always clear. Your workers are not independent contractors because you say they are – and there can be costly tax implications if you get it wrong.

Before you engage an independent contractor make sure you are clear on the nature of your relationship and familiarize yourself with the government criteria used to judge the status of that worker.

Below are three steps you need to take to ensure regulatory compliance when hiring an independent contractor.

1. Understand the Significance of Worker Classification

Misclassifying workers is a common business slip-up. Take, for example, this scenario described in a great article by Minda Zetlin on Inc.com about common and costly mistakes that businesses make when it comes to classifying contractors

In the article, Zetlin poses a seemingly clear cut question:

“Which of these workers qualifies as an independent contractor?

a)      A newspaper carrier paid for each copy delivered

b)      A knife salesman who works on commission, rents his own office, and pays his own staff

c)       A consultant who works part time for a marketing firm”

I must admit, my immediate response was “all of the above” and, indeed, each of the workers described was labeled as a contractor by the company he or she worked for. However, only the third example is a true contractor. The first two examples are, in fact, legal company employees, as determined in court rulings.

It is critical that you, the employer, correctly determine whether the individuals providing services are employees or independent contractors. Generally, you must withhold income taxes, withhold and pay Social Security and Medicare taxes, and pay unemployment tax on wages paid to an employee. You do not generally have to withhold or pay any taxes on payments to independent contractors. Getting it wrong can be costly resulting in penalties and back-tax payments for the business owner.

2. Know the Regulatory Criteria Used to Judge Worker Status

Here is a basic definition from the IRS of what classifies a person as a contractor as opposed to an employee:

• Independent Contractor – The general rule is that an individual is an independent contractor if you, the person for whom the services are performed, have the right to control or direct only the result of the work and not the means and methods of accomplishing the result. Essentially independent contractors are considered to be in business for themselves. They take care of their own tax obligations and benefits.
• Employee – Anyone who performs services for you is your employee if you can control what will be done and how it will be done. This is so even when you give the employee freedom of action. What matters is that you have the right to control the details of how the services are performed.

If you are not clear whether a particular worker is an employee or an independent contractor, you should file Form SS-8, Determination of Worker Status for Purposes of Federal Employment Taxes and Income Tax Withholding with the IRS. They will review the facts and circumstances for you and make an official determination of the worker’s status.

The Small Business Administration also has more information that can help you determine the difference between an employee and a contractor.

3. Understand and Maintain Your Tax Obligations with Regards to Contractors

If you determine that you are using an independent contractor, you will need to file some paperwork with the IRS and pay the associated taxes. This means maintaining W-9 forms, contractor’s business licenses and certification of insurance, as well as filing a 1099-MISC form to report payments.

Other Resources

For more, check out helpful information from the government’s Hiring Independent Contractors resource page on Business.gov.

Filling out forms – often a barrage of forms – can feel like the necessary evil of business. Larger companies have different departments in charge of handling their own required forms. Small business owners, however, are solely responsible for all forms regarding every part of the business. This is often one of the most difficult, confusing, and frustrating parts of being a business owner.

Luckily, there’s help.

Forms.gov

For a big-picture perspective, there’s Forms.gov. This website is essentially a massive catalog of more than 5,000 federal forms, from tax forms to small-business forms to Federal Emergency Management Administration (FEMA) forms. Any kind of form you’re looking for is here.

As this is such a large catalog, it may be difficult to find what you’re looking for unless you know precisely the name and/or number of the form in question. For example, if you’re trying to find out what tax forms you are required to file, and you type “tax” in the search field on Forms.gov, you’ll get a listing of every tax form available – including the Currency Transaction Report for Casinos in Nevada. Maybe this what you were looking for. Probably not.

Forms.gov is a fantastic resource. And, there are other resources you can use as well.

Business.gov

The SBA’s Business.gov was originally meant to be a portal for federal forms. While it has evolved into a critical resource for small businesses, it’s still a great resource for forms.

For example, Business.gov has a main Government Forms Page. At the top of the page you’ll find a listing of the 12 most-requested forms by small-business owners as well as instructions on how to fill out these forms. This list includes the Employer Identification Number (EIN) application, W-2, W-4, and W-9 tax and withholding forms, quarterly and annual federal tax returns, and more. As you might imagine, most of these top 12 are tax forms.

Further down the page you’ll find forms and appropriate links relating to Loans and Financial Assistance, Government Contracting (8(a) forms), Occupational Health and Safety (OSHA record keeping forms), Patents, Trademark and Copyrights, and Taxes.

You’ll also find a range of resources regarding employment, from the I-9 Employment Eligibility Verification form to a link that provides a state-by-state list of new hire reporting centers, so employers can learn and understand their individual state requirements. You’ll also find a listing of forms for hiring foreign workers as well as migrant and seasonal agricultural workers.

Easing the Pain

As a business owner, required forms can be your nemesis. My advice: Face the enemy! It may be easier than you think to emerge victorious.