SEPTEMBER 2004
ABCs of Accounting:
Small-business owners have many business relationships
Small-business owners have many business relationships – including relationships with employees and independent contractors.
In some cases, it may be very obvious which type of relationship exists. In others the distinction may not be so clear. The most common way to determine which type of relationship exists is by looking at the control that is exercised over what work is done and how it is done. If you control how the work is done, when it is done and where it is done, you probably have an employee. An employee suffers no direct financial consequence if the work is not completed when required and cannot increase their profit by working more efficiently. In contrast, if the end product is the only control that you exercise over the worker and if that worker will be penalized financially for not completing the work product when due, you have an independent contractor. If the worker has other clients, you likely have an independent contractor. Examples of this would be accountants, lawyers, software consultants, etc.
The IRS has 20 factors that it uses to evaluate whether a worker is an employee or an independent contractor. The IRS is very concerned about this issue since many businesses designate workers as independent contractors to avoid paying the employer’s share of Social Security tax and to avoid the paperwork involved in withholding federal income taxes on the employee. These are the factors that the IRS looks at to determine if a worker is truly an employee or an independent contractor:
Do you require the worker to comply with instructions? Do you train the worker? Are the worker’s services an integral part of the business? Must the worker’s services be rendered personally? Can the worker hire, supervise and pay assistants? Is there an ongoing relationship? Do you establish what hours the worker must work? Is full-time work required? Must the work be performed on your premises? Must the services be performed in a set sequence? Are reports required, either verbal or written? Is the worker paid by the hour, week or month? Are business or travel expenses reimbursed? Does the worker supply her own tools and materials? Does the worker invest in facilities? Can the worker profit or loose depending on how well the activity goes? Does the worker provide services to more than one business at a time? Does the worker make services available to the public? Do you have the right to discharge the worker? Does your worker have the right to terminate the work relationship?
As you can see, some situations can be extremely difficult to evaluate. If you want the assistance of the IRS, you can submit form SS-8 to determine employee or independent contractor status. The form is three pages of questions, both objective and subjective. Even if you do not file the form asking for an IRS determination, it will give you a good idea of the types of things they look at. You can download the SS-8 from the IRS Web site at www.irs.gov.
Once you know for sure that you have an independent contractor, there is special reporting that must be done at the end of the year. If you pay an independent contractor more than $600 per year for rents or services, you must send them a Form 1099-Misc. This form is a multi-part form like a W-2 and can be obtained at any office supply store. Once completed, a portion of the form is sent to the independent contractor, a portion is sent to the IRS and a portion is retained in your records. The form comes with very easy to follow directions. The form must be completed and mailed to the independent contractor by January 31 following the close of the calendar year and include all payments made during that year. The IRS copy is due to them by February 28. This gives the contractor an opportunity to review the 1099 and contact you with any questions or errors before the form is filed with the IRS.
The record keeping that comes with having people assist you in your business can be a hassle, but without help from others, the size and scope of your business will always be limited to your abilities and time.
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ABC's of Accounting:
