As a small business owner, one way to avoid problems with employees and taxes at the same time is to use independent contractors to do work for you. This can relieve your company of many of the burdens that come along with federal laws as well as the obligation to pay social security and medicare taxes for employees.

What is an independent contractor?

It is basically a separate business or businessperson that you pay to do a job for you. You pay them for a service and at the end of the year if the amount paid out exceeds a certain number you have to file a 1099, which is similar to a W-2. This status is in contrast to that of an employee.

Independent contractors are frowned upon by the IRS

Because it is easy for independent contractors to cheat on their taxes the IRS has strict regulations on who can or cannot be classified as an independent contractor. Also, companies who use independent contractors are at a higher risk of getting audited.  For example, if you use independent contractors in a position not traditionally held by regular employees you will be on the IRS’ radar. So don’t start hiring secretaries as independent contractors!

How is it determined who is or is not an independent contractor?

The analysis of independent contractor status comes primarily from the amount of control that the contractor has over their tasks. If you agree to pay a plumber a fee and he has complete control over how to do the pipes in your house, he is probably an independent contractor. However, if you tell the plumber when and how to do the work, and provide the tools and materials, he will probably be classified as an employee.

Advantages of independent contractor status

• Lower taxes: You do not have to pay Social Security, Medicare, unemployment, or other employment taxes
• Less paperwork: You do not have to handle federal withholding deposits or the monthly employer returns to the state or federal government.
• Less insurance: You do not have to pay workers compensation insurance or insurance against possible liabilities
• More flexibility: You can use independent contractors only when you need them

Disadvantages of independent contractor status

• The IRS: they are very strict about who can be classified as an independent contractor and you are more likely to get audited if you use them frequently
• While employees usually cannot sue you for their injuries (if you have them covered with worker’s compensation) independent contractors can sue you if their injuries are your fault
• You have less control over how the independent contractor performs her job and you have less flexibility in terminating him if you are not satisfied with the job they are doing

Depending on the type of business you have, independent contractors may or may not make sense for you. You will have to carefully consider your own business plan in deciding how to hire your workers. For more detailed information on how to use independent contractors contact local counsel.[1]