Businesses are increasingly considering the use of self-employed individuals like independent contractors and freelancers, sometimes assigning these workers duties that were once reserved for full- or part-time employees. While taking on independent contractors may be a smart business decision, proceed with care: The government has strict rules for how businesses must treat freelance workers, and it’s been cracking down hard on companies that break the rules.
Freelancers are on the Rise
About one-third of the U.S. workforce (53 million) is considered a contract, freelance, or temporary worker, according to a 2014 survey by the Freelancers Union and Elance-oDesk. That portion is expected to surpass 40 percent by 2020. There are several reasons that may explain the trend: For one, many companies enjoy the flexibility of having workers they can use as much — or as little — as they need without having to pay them for downtime. In general, companies are not required to offer benefits like health insurance or paid sick leave to workers who are correctly classified as freelancers, as they often do with full-time employees. At the same time, many workers are embracing the freelance lifestyle because it allows them to carve out their own work schedule and career path including working for multiple companies simultaneously.
Separate Payroll Requirements
From a payroll perspective, companies aren’t required to withhold taxes from correctly classified independent contractors’ pay or pay the employer portion of social security, Medicare, and state unemployment taxes, as they do with employees. However, companies are required to keep track of contractors’ earnings and report to the IRS those earnings on a 1099-MISC tax form for all contractors who earned more than $600 in a calendar year. Businesses must send out Forms 1099 to independent contractors on or before January 31 each year for the prior calendar year.
IRS “Common-Law” Rules
Independent contractors are business owners and should be treated as such rather than as an extension of employed staff. To help them determine whether an individual is correctly classified as an independent contractor the IRS relies on specific rules, “common-law rules,” which fall into three areas of control that exists between the company and the worker:
- Behavioral Control: What level of control does the business owner have over how work is performed? For example: While establishing project deadlines is likely appropriate for both employees and independent contractors, requiring the worker to work specific hours or in a specific location may be more indicative of an employee status.
- Financial Control: How much control does the business have over the business aspects of the worker’s job? For example: the extent to which the worker has unreimbursed business expenses, the extent of the worker’s investment, and the extent to which the worker can realize a profit or incur a loss.
- Type of Relationship: What kind of written contracts exist between employer and worker? Is the worker offered employee benefits like a pension plan, insurance, sick leave, or vacation pay?
If an employer needs assistance determining if a worker should be classified as an employee or an independent contractor, they should consider consulting with a human resource professional or legal counsel in order to mitigate their exposure to misclassification issues.