How to Spot an Independent Contractor.

• Author: Spendlove, Gretta
• Position: Tax law - Brief Article - Statistical Data Included

Failure to properly distinguish between employees and independent contractors could result in big back tax penalties.

In today's workplace, many companies have chosen to play a game of high-stakes gambling with the IRS and don't know it. That's because they employ a variety of "workers" without understanding how the IRS assesses tax obligations depending on the worker's relationship with a company.

Today's definition of a "worker" in the United States covers as many diverse relationships as the word "family." Some are traditional full-time on-site employees, others telecommute from home, while still others work at the employer's business, but on a part-time or piecework basis. Some of these workers are considered traditional employees while others are classified as independent contractors (ICs). Sorting out who's who can be complex.

For those workers that can be classified as "employees," employers must pay federal withholding tax, provide workers compensation insurance, and comply with minimum wage laws. On the other hand, employers need not comply with such tax and compensation laws for independent contractors. If employees and ICs are not classified properly, businesses may find themselves in a losing game with the IRS, since IRS audits often reclassify ICs as regular employees and assess hefty back taxes and penalties to companies that have violated employee tax laws.

How can businesses be sure they properly distinguish between employees and ICs? The heart of the distinction lies in understanding who controls the means and details by which work is done. The more control the employer has, the more likely the worker will be defined by the IRS as an employee.

The following scenario helps illustrate this: Aardvark Advertising lands a big account and wants Amy, Betsy and Carl to work on the ad campaign.

Besides working for Aardvark, Amy has other clients and works at home using her own computer. Aardvark pays Amy $2,000 for her portion of the project. Amy is considered an independent contractor because she has major control over when and where the work gets done, is paid a fixed fee, and owns her own tools and supplies.

Betsy works at Aardvark, using its computer and supplies. She is paid a salary and benefits, maintains regular working hours, and works only on Aardvark projects. Betsy is considered an employee.

Carl works at home, but uses a computer and supplies provided by Aardvark. He works for Aardvark as well as other clients. He...