One of the earliest decisions a start-up will make is whether it will engage independent contractors or hire employees. Some new businesses prefer to utilize independent contractors to do specific tasks, like accounting functions, because contractors can provide hiring flexibility and cost savings. A business can lower its expenses on things like payroll taxes and employee benefits if it engages an independent contractor instead of an employee for certain projects.
However, it is not enough to merely call a worker a “contractor” instead of an employee. Further, it can be costly if an employer misclassifies an employee as an independent contractor. For instance, the business could be liable for withholding taxes for the worker for the time he or she was employed.
The IRS and the states utilize different tests to determine whether an individual is an employee or independent contractor. Some states examine the previous IRS 20 factor test to determine the appropriate classification of workers. The IRS looks at a number of factors that include the amount of control the business has over the individual’s work (that is, the business’s control over how the individual does the task and the business aspects of the work). Notably, the IRS examines the type of relationship between company and worker, including the description of that relationship in written contracts. It is essential for a company engaging an independent contractor to have a written agreement that establishes the terms of the relationship.
Note that there is no definitive test or factor for determining whether a worker is an employee or an independent contractor, and any such determination may vary depending on the type of business. Any new business will want to contact an attorney who focuses on tax or labor and employment issues to guide it in appropriately classifying its workers.
Independent contractors, when used properly, can be a great option for start-ups looking for help but without the cost associated with hiring an employee.