Employee or Independent Contractor?


Hiring an independent contractor offers employers many advantages. Unlike for traditional employees, employers do not pay taxes on independent contractors’ wages, and are not expected to provide benefits. Employers often save 30 to 40 percent on labor costs by using independent contractors. In addition, as independent contractors are generally hired for a specific period or project, employers have no obligation to rehire them after each contract period or project is complete.

However, employers should be cautious when classifying individuals as independent contractors. Misclassifying an employee as an independent contractor can have serious financial and legal consequences.

At the end of each year, the Internal Revenue Service (IRS) requires employers to issue Form 1099 to every contractor to whom they paid $600 or more during the tax year and file Form 1096 with the IRS to report payments the employer made to contractors.

The IRS, the U.S. Department of Labor and various state agencies constantly monitor compliance with employee and independent contractor classification using a variety of criteria. Using the Employment Tax Examination Program (ETE), special IRS teams investigate misclassification of workers through audits. Employers that file Form 1099 are subject to audits, as are employers in industries that tend to abuse the privilege of hiring independent contractors.

If a company is found in violation, the IRS will impose the following penalties in addition to attorney and tax advisor’s fees:

     • Retroactive payment of back taxes for the individual

     • Interest calculated from the time when payments were due

     • Penalty fines of up to 100 percent of the amount due

     • Retroactive contributions to the individual’s Medicare and Social Security,
     federal and state unemployment taxes, and workers’ compensation benefits