There are many benefits to hiring a contractor rather than an employee. They are generally cheaper in labor costs, they are less of a liability to the companies employing them and there is more flexibility in terms of hiring and dismissing them. However, it’s extremely important to ensure that you are making the correct classification—if you hire an individual as an independent contractor and it is discovered that they meet the legal definition of an employee, it can bear a number of expensive legal consequences, such as:
Reimbursing the individual for wages they should have been paid under the Fair Labor Standards Act, including overtime and minimum wage
Providing employee benefits, such as health insurance, retirement, etc.
Paying workers’ compensation benefits to any misclassified employees injured on the job
Paying back taxes and penalties owed for federal and state income taxes, Social Security, Medicare and unemployment
While there is no single test used to determine whether an individual is an employee or an independent contractor under the Fair Labor Standards Act, the U.S. Small Business Administration suggests taking the following guidelines into account:
The extent to which the services rendered are an integral part of the principal’s business
The permanency of the relationship
The amount of the alleged contractor’s investment in facilities and equipment
The nature and degree of control by the principal
The alleged contractor’s opportunities for profit and loss
The amount of initiative, judgment, or foresight in open market competition with others that is required for the success of the claimed independent contractor
The degree of independent business organization and operation
For more information about the tax implications of hiring an employee or an independent contractor, and to fill out Form SS-8, Determination of Worker Status for Purposes of Federal Employment Taxes and Income Tax Withholding, visit the IRS Independent Contractor or Employee page.
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