Many companies use independent contractors to slash payroll taxes and the high cost of fringe benefits. But using outside workers can result in other problems. It's no secret that Uncle Sam wages battle with businesses over freelancers. And the situation is getting worse.
If your independent contractors are legitimately independent, there's no problem. But if they're employees in disguise, the IRS can "reclassify" them as employees and you're slapped with hefty bills for back taxes, plus interest and penalties. And audits by state agencies are also common and frequently occur when freelancers apply for unemployment compensation.
Your company's pension plan isn't immune either. As independent contractors, workers are generally excluded from retirement plan contributions. If the IRS reclassifies them, your company may be penalized and your qualified plan might be disqualified.
To stay on the safe side, consult your tax adviser and make sure freelancers sign contracts that specify:
They are not employees for federal income tax purposes and are responsible for paying their own Social Security and Medicare taxes.
They are not entitled to employee benefits, are not covered by workers' compensation, and maintain their own insurance coverage.
Have your regular employees sign contracts, too. By varying the two types of documents, you can make the case that both categories of employees perform different tasks.
Here are four more tips to safeguard your company:
1. Consistently treat all workers performing similar tasks as either independent contractors or employees. If contractors must wear ID badges or use company vehicles, make sure their contracts explain why. For example, the policy was instituted after customers expressed safety concerns about deliveries in unmarked cars.
2. Give outside workers considerable discretion about how and when they perform their duties. In general, independent contractors must control the way they get the job done.
3. Send each contractor a Form 1099 showing non-employee income if you pay $600 or more in a calendar year.
4. Don't supply freelancers with services you give employees. Some companies have run into trouble with the IRS for providing contractors with office space, computers, cars and other perks. Independents generally furnish their own tools and materials.