Protect Yourself From IRS Fines: Independent Contractor Versus Employee Differentiations

Entrepreneurs are increasing in number across the country and many of them are operating from home-based offices. As these businesses grow, the owner brings on independent contractors to help with the burgeoning business. However, recently the independent contractor status is being challenged by the IRS and entrepreneurs need to protect themselves.

It is estimated that there are more than eight million individuals claiming the independent contractor status for tax filing and of those, close to 90% are not paying the correct amount of taxes according to the IRS. Because of this, the IRS is clamping down on this filing status and is making a push for independent contractors to become re-classified as employees. What does this mean to business owners? If could mean that if the IRS determines you have incorrectly classified an individual as a contractor, when in fact the IRS determines he or she is an employee, you could be liable for paying back taxes for Medicare, Social Security, and Unemployment taxes. The entrepreneur could also face legal prosecution from the IRS.

How can you, as a business owner, protect yourself? Here are some tips to consider. (As with all items related to IRS and tax filing, it is imperative that you speak with your trusted accountant or financial advisor):

  1. Ditch the applications. Independent contractors should not fill out applications for employment. The contractor should present a proposal for the tasks he or she will perform. An application could be “proof” in the eyes of the IRS that the individual was applying for a job, i.e., looking to become an employee, not a contractor.
  2. Pay the contractor on a per project basis and not an hourly rate. There may be exceptions to the rule, but paying an hourly wage could mean that you are “managing” the contractor just like an employee. Independent contractors offer a per-project price regardless of the hours it takes to complete the project.
  3. Always get an authorized project proposal. The proposal should list the contractors’ obligations and deadlines associated with specific tasks. The wording on a contractor’s proposal can make all the difference in the world. For example, “contractor will report quarterly taxes” versus “contractor will assist with accounting tasks as required” could raise red flags with the IRS. “Assisting with tasks” is viewed much differently as “reporting quarterly taxes.”
  4. Avoid micromanaging hours worked. As an independent contractor, the individual has the freedom to perform the task whenever and wherever he or she sees fit as long as the deadlines agreed upon are met. Setting deadlines is routine, however telling the contractor what hours you expect him or her to be available is not.  That expectation falls under the category of an employee that needs to be at the office from 9 am to 5 pm.
  5. Your contractor needs to supply his or her own workspace and office supplies. Independent contractors should have the tools necessary to complete the task they are hired to complete.

Also, remember that a true independent contractor is free to work with other clients. While you may be able to keep the contractor busy on a full-time basis, he or she is free to seek other clients. The IRS website,, is a source for educational information on the differences between independent contractors and employees.



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