Hiring Independent Contractors

* Reduce employment costs
* Avoid treating contractors like employees
* Know benefit-plan regulations
* Document arrangements

James P. McElligott, an employment and benefits lawyer with the Richmond, VA-based firm McGuireWoods LLP (www.mcguirewoods.com), outlines benefits and potential issues of classifying certain hired persons as independent contractors.

Independent contractors reduce employment costs. Employers do not have to withhold part of their wages for income tax purposes or pay FICA (Federal Insurance Contributions Act) and FUTA (Federal Unemployment Tax Act) taxes on those wages. Employers often do not offer employee benefits to contractors. However, contractors are often paid higher hourly wages.

Avoid treating contractors like employees, McElligott says. If the IRS determines that businesses have misclassified employees as independent contractors, they may owe taxes and past benefits, McElligott says. In cases where a company allegedly misclassifies employees as contractors, the courts and the IRS consider the facts of the case rather than strictly relying on the language of their agreements. Despite complex IRS regulations (see IRS Pub. 15-A, Employer’s Supplemental Tax Guide), "no bright-line test or safe harbor exists for determining whether a worker is a common-law employee or an independent contractor," McElligott says.

Sen. Kit Bond, R-Mo., introduced legislation on May 7, 2001, to replace the IRS’ 20-factor determination test with just two, general criteria—a contract specifying that the individual is not an employee and proof that the contractor manages payments, taxes and benefits through his or her own corporation. McElligott applauds this move. "Senator Bond’s bill provides clear, reasonable standards that promote tax compliance, not tax confusion," he says.

McElligott suggests that employers know benefit-plan regulations to avoid problems. "A common mistake is exclusion of part-time or temporary employees from benefit plans when there is no plan language that justifies such exclusions," he says.

He also suggests that employers document employment arrangements with independent contractors by using well-written contracts that describe the working relationship, including the contractor’s obligation to pay self-employment taxes. Employers should constantly monitor employment practices to be sure they match agreements.

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