Working with Independent Contractors

Outsourcing can be a lucrative option to cut costs

0521_contractor-exclusiveIf you can’t afford the costs of hiring a new employee, but you do have a need for talent, consider outsourcing to find a self-employed independent contractor to handle the job. Contractors can work on a per-project basis, which could make accounting easier, reduce overhead and reduce the employer’s tax burden.

“When someone is an employee, their employer pays half of their payment for Social Security taxes and other expenses,” says Elaine “Laney” Johnson, president of Financial Business Solutions in Doylestown, Pennsylvania.  “But when they receive income as an independent contractor, they are in fact the employer and employee, so they have to pay the entire tax amount (and the business that hires them does not).”

Analyze the worker relationship. The savings can be significant, but William Levan Byrd, a sole practitioner CPA in Sumter, South Carolina, says entrepreneurs who are considering this option need to respect the service provider’s boundaries.  That’s because the IRS pays special attention to the amount of “independent” a worker has in their “independent contractor” role.

“If a worker completes tasks in their own hours, uses their own equipment, and completes the work in their own way, they may be considered an independent contractor,” says Byrd.  This is often the case with insurance agents, marketing consultants and independent sales representatives.

Alternatively, if a company controls when and where a worker shows up for the job, and pays for all their equipment, the IRS may decide that worker is really an employee and should be taxed accordingly, says Byrd.

As a business owner, if you’re unsure about a worker’s status, Byrd suggests filing out Form SS-8, a checklist that allows the IRS to make that determination.  For more information, visit IRS.gov.

Decide status based on worker role. Even though hiring an independent worker can reduce costs, business owners shouldn’t consider the option solely because of money concerns, Byrd says.

“The biggest mistake I see companies make about independent contractors is to hire them based on cash flow issues,” he says.  “It’s not a decision to be made based on available cash.   It’s a decision to be made based on the appropriate facts of the business situation.  The law is very clear about who can and can not be an independent contractor.”

If a company improperly classifies an employee, the IRS can audit them, require them to pay back employment taxes and would likely assess penalties, says Toni Levy, CPA and owner of Toni Levy and Associates in Louisville, Kentucky.  “Some small businesses owners who get caught find that their penalty fees are higher than the amounts they paid their (misclassified) workers in the first place,” she says.  “It’s the price to pay for disobeying the law.”

Keep paperwork current. Businesses that hire legitimate contractors need to file certain documents at tax time, says Johnson , president of Financial Business Solutions.

“Make sure contractors fill out a Form W-9 before any work begins,” says Johnson.  This is the IRS form used to request the contractor’s correct name, mailing address, taxpayer identification number (TIN) and business information. Blank forms are available from IRS.gov.

Companies should also be prepared to send their workers tax documents after the end of the year.  If a sole proprietor or small company (not a corporation) performs services that total more than $600, companies should annually send them a Form 1099 for tax reporting, says Johnson.

For companies that are growing in need, but don’t have a requirement to bring on an employee, hiring a self-employed contractor can be a cost-effective way to add talent to the team.