I use independent contractors and understand that the IRS takes issue with who is an independent contractor or an employee. What can I do to stay out of trouble?
The IRS uses a 20-point guideline to determine who is an independent contractor. But those 20 points are ambiguous. They don't provide a clear method of distinguishing between independent contractors and employees. IRS Publication 15-A gives the 20 guidelines and a general overview of the differences between independent contractors and employees.
In general, if you control when, where and how individuals perform their work, then they are considered employees. If they sell services to the general public or other businesses and present themselves as a business, you have a strong foundation for treating them as contractors. Follow these basics to protect yourself when using independent contractors.
Use written agreements
Independent contractor agreements can be found at office supply stores, in small-business legal document books and in legal document computer software programs. It's a good idea to have your attorney look over the agreement.
Complete W-9s
This form provides the independent contractor's business name, federal I.D. number or social security number and other pertinent business information. Fill one out for each contractor you use.
Get business information
Keep copies of contractors' business cards, letterheads, etc. If they operate under business names, get copies of their DBA (doing business as) filings. If they don't have any of these, question if they are operating as independent contractors.
Require invoices
Insist that contractors provide invoices before you pay for any work they performed.
Pay by check
Always pay by check, never in cash. Don't make checks payable to an individual unless the contractor does not have a formal business name.
Issue 1099s
If you pay a contractor more than $600 in a year, the IRS requires that you issue a 1099 to the contractor and send a copy to the IRS. To be safe, issue 1099s to all contractors, regardless of how much you pay them.
One final point. Many small-business owners think most problems with independent contractors arise if the IRS comes knocking on the door. This is a misconception. Problems most commonly develop between businesses and the contractors themselves. Unscrupulous independent contractors may go running to the state unemployment office when their services are terminated. If you can't substantiate that the person was an independent contractor, the state will determine the person was an employee, and you're guaranteed to end up with an audit. To avoid trouble, make sure independent contractors are in business for themselves. If you can't convince yourself they are legitimate businesses, you'll probably have a difficult time convincing the IRS or your state unemployment office. For more information about independent contractor status, link to the IRS online via the NASE Web site at www.nase.org.
What is the best way to establish rates and fees for my service business?
A good starting point is to determine what the competition is charging in your immediate market area, and I emphasize "immediate" market area. For example, a desktop publishing business in Minneapolis probably can't charge the same rates as one in New York City. Determine the market rate in your area by calling competitors and asking what they charge. Some creative conversation can get you plenty of rate information. If you feel uncomfortable making the call yourself, have a friend call. You can also contact a local Chamber of Commerce. Many chambers conduct annual surveys of businesses to establish current rates and then publish that information for their members.
Once you determine market rates, you can adjust your fees based on your
abilities, experience and expertise. And remember -- if you get every job you
bid, you're probably undercharging; if you lose most of your bids, you're most
likely overcharging.
Return to the table of contents
Copyright 1997 © National Association for the Self-Employed All Rights Reserved. Any redistribution of this information without permission is strictly prohibited.