Beware the Contract Worker Trap

Question: When we started our business a year ago, we used independent contractors to keep costs low. Now one of them is claiming they were really an employee and has filed a complaint with the state. We thought our arrangement was both prudent and proper. How do we avoid such hassles in the future?

Answer: You've raised one of the stickiest issues facing small business owners today. Are the people you bring in to provide specific services for your business "independent contractors" (non-employees)? Or are they actually employees?

A great deal hangs in the balance. And unfortunately, it's not merely up to you to choose. The IRS and equivalent state agencies are strict on worker classification issues. They look askance at this type of relationship because independent contractors are responsible for paying their own taxes and it's tougher for the IRS to make sure they're doing so.

Keep in mind that independent contractors work for themselves. They operate their own business and have you as a client. You are not their employer and don't set their hours or control how they perform their work.

Government agencies tend to see it this way: A worker is an employee of your business unless you can prove otherwise. The key issue often comes down to this: How much control does your business wield over the worker?

Here are some "tests" of independent contractor status and steps you can take to avoid trouble:

• Contractors control when and where they work. While they might receive job specifications from a client, they are not given specific instruction on how to accomplish a task. Avoid setting a pattern of daily or weekly work hours dictated by your business.
  
  
• Contractors do not usually have a permanent or continuing relationship with the business and have time to pursue other clients. Compensate contractors on a per-job basis, rather than weekly or monthly.
  
  
• Contractors are paid to complete a set task and may bring in others to complete it, at their discretion and on their payroll.
  
  
• Contractors should use their own tools and technology and be responsible for their incremental expenses. They have an investment in their own "business" and should be able to perform their duties without your facilities.
  
  
• 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 have for employees.
  
  
• Independent contractors are subject to making a profit - or suffering a loss - based on their own skills and expertise. Always require an invoice before making payment.

Consider these steps as well.

1. Before you agree to an independent contractor relationship with anyone, make sure you understand what that means and carefully weigh the pros and cons. If you misclassify a worker, you could be liable for back employment taxes plus penalties.
   
   
2. Review the IRS list of factors used to determine whether a worker is an employee or independent contractor (see the resources below).
   
   
3. A simple agreement that specifies the independent contractor relationship can help validate your position, but it won't be enough by itself. Sample agreements are available online at Business Owner's Toolkit (toolkit.cch.com), LawDepot.com and Nolo.com.
   
   
4. Ask the independent contractor to fill out a questionnaire and prove that they operate their own independent business. Helpful information includes their registered business name, business bank account and how the business is structured (LLC, corporation, etc.).

Check out these resources for further help:

• The Small Business & Self Employment section of the IRS Web site offers the federal tax agency's view on who qualifies as an independent contractor and who does not. You'll find helpful case examples and a list of factors that the IRS considers. Visit www.irs.gov/smallbiz.
  
  
• Nolo, a self-help legal publisher, has an extensive section on its Web site devoted to the classification of workers as independent contractors or employees. Advice is authoritative and very helpful. See the Business & Human Resources section at www.nolo.com.
  
  
• Business Owner's Toolkit, a terrific Web site produced by CCH Inc. and available free, has numerous articles, sample forms, tips and advice devoted to the independent contractor issue. Visit www.toolkit.cch.com.