The following situations usually arise when firms use contractors. More often than not, the firms don’t think twice about the arrangement until the IRS or other government agency challenges how they classified the workers.
Test your knowledge of the worker’s status in these scenarios:
- A company purchases supplies for the contractor to use in his work for the company: The company hires a contractor to landscape its grounds. The company is able to purchase sod at a lower rate than the contractor and does so as a favor. The contractor provides all the labor and submits an invoice when the project is completed. Further, the contractor (not the company) determines how to undertake and complete the project. Will this scenario raise any red flags with the IRS?
Answer: The IRS will most likely cite the purchase of the sod as an example of the company’s interfering with the contractor’s purchasing prerogatives and, therefore, a factor supporting employee status.
Recommendation: Don’t purchase or provide any supplies or equipment for contractors. This includes items you no longer use and outdated or surplus equipment. You can, however, sell or rent these items to the contractor.
- A company lends equipment or personnel to the contractor: The company hires an independent contractor to reprogram all of its computers. It suggests that the contractor work with the on-staff computer “guru” so that the contractor can save time and focus on the more difficult aspects of the reprogramming. Will this affect the contractor’s status?
Answer: The IRS may conclude that the contractor is an employee if the company is continually involved with the project and controls how it is done.
Recommendation: Once you hire a contractor and give him or her the assignment, your involvement should be minimal until the project is completed. It’s fine to establish an early due date during the course of the project to make sure that the goods are delivered as you specified. (Remember that you do have control over accepting or rejecting the finished result.)
- A company provides ongoing supervision of a contractor’s performance: The company hires a painter to do the walls in a suite of offices. The office administrator checks on the painter’s work every hour, telling him that the trim is the wrong color or pointing out when he’s missed a spot. Is the employer painting himself into a corner?
Answer: The IRS could use the administrator’s close supervision as evidence of an employer-employee relationship.
Recommendation: You must trust your contractors to supervise their own work until the initial due date. If the work is below expectations (or the contractor fails to meet the deadline) at that point, you can criticize it or terminate the contract.
The IRS estimates that 80% of workers classified as “independent contractors” are actually employees.
- A company requests that, for the duration of the contract, a contractor work only for its company: After hiring an independent contractor to build additional offices, the company asks him not to take on any additional work until the offices are completed. Is that a good idea?
Answer: The company is limiting the contractor’s ability to offer his services on the open market — this is a factor supporting employee status.
Recommendation: Before you hire the contractor, determine how much time the project will take, and set realistic deadlines. If the contractor has other clients whose demands conflict with yours, it’s up to him to balance his workload. He may very well choose to subcontract out part of the job. If your goal is to keep the contractor from revealing a trade secret, you can require him to sign a confidentiality pact as part of the contract.
- A company provides continuous, ongoing work for a contractor: A freelance architect is hired by a company to do some planning for future building sites. The architect’s work is so good that the company asks her to stay on indefinitely as an independent contractor to handle additional design duties. Is she still a freelancer?
Answer: Again, the IRS might find that the independent contractor has been converted to an employee under these facts.
Recommendation: Work assignments with contractors must be on a per project basis, with all subsequent work assigned in that manner. Ideally, each assignment should be a separate relationship between the contractor and the hiring company.
If you classify any workers as “independent contractors”—or have plans to do so—now is the time to make sure you get that classification correct.