IRS scrutiny can wilt contractor strategy

TIPS FOR SMALL BUSINESS

May 04, 2008|By STEPHEN L. ROSENSTEIN

Small business owners often try to save money by using independent contractors instead of hiring full-time employees. Using independent contractors means the business doesn't withhold taxes, pay Social Security or Medicare or meet numerous other employer responsibilities.

Many such arrangements, however, wilt under Internal Revenue Service scrutiny. The strategy can backfire if someone later claims he should have been treated, and paid, as an employee.

Deciding who can legitimately work as an independent contractor and who must be given employee status has become a difficult matter for small business owners. You can't simply choose what's best for you. The IRS and equivalent state agencies are strict on worker classification issues.

Remember, independent contractors work for themselves. They operate their own businesses. You are their client, not their employer. You don't dictate their hours or control how they perform their work. In the eyes of most government agencies, a worker is an employee unless you can prove otherwise.

Plan to compensate contractors on a per-job basis, not weekly or monthly. Since contractors are paid to complete a set task, they may bring in others to help, at their discretion and on their payroll. They also should use their own tools and be responsible for their incidental expenses.

Contractors can't be fired as long as they produce results that meet their contract specifications. Do not include them under any insurance or benefits coverage you offer employees. And always require an invoice before making payment.

Before you enter into an independent contractor relationship with anyone, make sure you understand what that means. If you misclassify a worker, you could be liable for back employment taxes plus penalties.

Stephen L. Rosenstein is co-chairman of the Greater Baltimore SCORE Chapter #3. Call 410-962-2233 to speak to a SCORE counselor or visit www.scorebaltimore.org. To send a question to SCORE, e-mail smallbiz@baltsun.com

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