Connections for Success

 

03.25.11

To Contract or Not To Contract, That Is The Question
Laurence Sophian

The question, to contract or not to contract has baffled business owners and organizations for as long as Shakespeare has been asking, “To be or not to be”.

The question is a good one, for hiring contractors is one of the ways employers try to lower their labor costs rather than hiring employees.  Hiring contractors enables employers to shift the responsibility for Social Security and Medicare taxes from the company to the worker, while neither party is subject to unemployment taxes.  At not-for profit organizations, where lowering costs so that more money is available for the programs of the organization are available is always a priority; there can be a great temptation to treat workers as independent contractors rather than employees.

In many cases, this treatment will be entirely appropriate.  However, you need to be careful.  The IRS has rules on when a worker has to be treated as an employee.  Violating those rules can subject your organization to interest and penalties for unpaid payroll taxes, even if the worker has paid the self-employment taxes, which independent contractors pay in lieu of Social Security and Medicare taxes.

So what’s the test?  Historically, the IRS judged this issue based on an analysis of 20 factors that surrounded the terms of how the worker was doing his/her job.  In essence, these 20 factors boiled down to one word – control.  The more control the employer appeared to exercise of how, where, and when the worker was doing their job, the more likely they were to be an employee.

Recently, the IRS has recognized that the old tests don’t reflect the way we work today.  Instead, they now look at 3 main categories in making this determination:

  1. Behavioral control – In this category, IRS considers what kind, and how extensive, the instructions you give the worker are, and whether you provide training about required procedures and methods.  The more of this you provide, the more likely the worker is an employee.
  2. Financial control – Here, the IRS looks at how much the worker has invested, whether the worker or the company pays any expenses, and whether the worker has the opportunity to make a profit or loss on the activity.  The presence of these factors would lean towards independent contractor.
  3. Relationship of the parties – In this area, the IRS looks to see if you are paying benefits, which would be a factor indicating an employment relationship, and whether there’s a written contract between the parties, which is more likely to suggest a contractor relationship.

As  you can see, these categories basically come down to the same test as the previous 20 factors – how much control do you, as the “employer” exercise over the way the worker performs their duties.

These tests don’t mean that you should shy away from treating workers as independent contractors.  As noted above, there will be many cases in which this is the right thing to do.  And the savings from doing so can be significant.  For example, if someone is earning $50,000, you can save $3,825 in Social Security and Medicare taxes if they can legitimately be treated as an independent contractor.  And that doesn’t even consider any unemployment tax savings.

As always we recommend that you consult with your accountant before making this type of decision.  Feel free to contact me directly if I can assist you in evaluating your organization’s options.

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