Your Taxes: Independent contractor vs. employee? Know the law |

Your Taxes: Independent contractor vs. employee? Know the law

by Michele Knight

The question of whether an individual is working as an independent contractor or an employee is not a new one. A study in 1996 showed that between 1988 and 1996, 90 percent of court cases challenging independent contractor status resulted in the IRS classifying the workers as employees, not contractors, forcing taxpayers to come up with over $751 million in back taxes and penalties. Shortly after these findings were released, President Clinton signed the Small Business Job Protection Act so that the burden of proof resided with the IRS, meaning the IRS had to prove that someone was an employee, rather than the employer having to come up with proof that a worker was truly an independent contractor. Business owners at that time could take a few steps to set up an independent contractor properly, such as having a written agreement, denying any fringe benefits and getting the contractor to set up their own business, and they could sleep well at night knowing they were most likely in the clear.While the question of independent contractor vs. employee hasn’t completely gone away, it hasn’t received much attention since that time. But times have changed. With the federal government and states on the hunt for additional tax revenues to help cover growing deficits, both levels of government are on the lookout for ways to collect more taxes, and this seems to be their latest solution. In Colorado, H.B. 1310 was signed into law by Gov. Ritter in June of 2009, which provides significant penalties of up to $5,000 per misclassified employee for a first offense and up to $25,000 per misclassified employee for subsequent offenses. These are in addition to the other taxes and penalties owed if an agency reclassifies your independent contractors as employees, including payroll taxes, overtime pay, and benefits. And you don’t think you’ll get caught? You’d be amazed how many happy independent contractors will head straight to the Department of Labor and call foul on you when a business relationship doesn’t work out!Trust me, this is not a mess you want to be in. So, how do you protect yourself? The IRS has a list of questions to ask, and these questions fall into three areas: behavioral control, financial control, and the relationship between parties. They are also willing to help make this decision for you if you file Form SS-8, but before you do, you should give some thought to the relationship between the business and the workers. Behavioral control relates to whether the business has the right to given instructions to the work, or requires workers to be trained to perform services using certain methods. Financial control examines who controls the business aspects of the worker’s job, including who pays the expenses, how much financial investment goes into the equipment or facilities used to perform services, whether works are paid on a regular schedule or by the job (employees usually received scheduled paychecks, whereas independent contractors receive pay by the job), and who takes on the risk when there is a business loss. The relationship between the parties should be clearly spelled out in a contract, and employee contracts usually include employee-type benefits such as insurance, vacation and sick pay, along with an indefinite term, while an independent contractor contract is usually project-specific with no benefits offered.Now is the time to take a close look at either the people working for you, or the business you are working for. While the IRS and the states reserve the right to go back and make a retroactive change to a status, I still believe it’s always in your best interest to make it right as soon as you know the situation is not being handled correctly.Michele Knight, owner of Knight Accounting & Technology, is a CPA and QuickBooks ProAdvisor based in Dillon. Visit for tax tricks & tips, including a blog to keep you up to date on the ever-changing tax world.

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