In our massively connected professional networks, handing work off to friends and associates is pretty common. But it also triggers some tax issues in the US.
When you pay someone to write an article, to be your virtual assistant, to redesign your site, to work with you on a project for your client, basically anytime you give work to someone else, the IRS views them either as an employee or a contractor (or as a statutory employee or statutory non-employee. Those are pretty uncommon, and we’ll talk about them at the very end.)
What difference does it make?
I’m sure you’ve watched big companies converting positions from employees to independent contractors because it’s cheaper. Independent contractors have to pay their own self-employment taxes and don’t receive any of the usual costly employment benefits.
As a small business owner or solopreneur, you might assume that anyone you work with is also independent, but a person can be your employee even if they live far away and work only part time with you. Unfortunately, if you think someone is a contractor, but the IRS decides they are your employee, you’ll get socked for a huge tax bill. So it matters.
What makes an employee vs. what makes a contractor?
The basic difference is control. For an employee, you have the right to control the details of how the services are performed. On independent contractors you control only the results, not the means and methods. Usually, when we pass work off to another entrepreneur, we give them complete control over methods. Just beware of taking too much control. For more info on this, check with the IRS.
What types of relationships get questioned most often?
The more work you do with an individual, the more likely that the IRS will take a look at the classification. So if you are working on assignments every day with same person, that’s a signal.
If you are the other person’s only client, or just one of a few, that’s another signal.
If the other person used to be your employee, that’s a big signal!
OK, so if you’ve got some signals, what do you do?
First, you want some documentation. Get at least a few of the following:
- Get a copy of their business card, ad, business website, etc. and file them. I’ve even used LinkedIn and JumpUp profiles to show independent status.
- Ask for copies of their invoices to other people. (Let them mark out the amounts, if they want.)
- Ask for a copy of their IRS Schedule C. (Once again, no amounts needed.)
- Get a copy of their LLC filing or business license, if they have them.
Second, prepare a contract explaining the independent relationship, outlining who owns the rights to the work product, etc., and get it signed. I’m no lawyer, so I’m going to point you to some online samples. Check the one at the Business Owner’s Toolkit and the one from Inc.com.
Keep this documentation for 5 years after you last do business with them. Really.
The goal is to show that the contractor really is in business and working for more than just one client (you). That should keep you out of trouble on this topic.
If I didn’t answer yes on any of the signals, am I in the clear?
Probably so. But I’m tellin’ you it won’t hurt to actually document it anyway.
What about employees?
We’ll be going into detail on how to deal with employees and payroll in another article. Oh, and tax forms like 1099’s. Sounds like another good article for our tax expert Maesz.
Statutory Employees and Statutory Non-employees
As promised, here’s a little bit more about statutory employees. This only applies in a few very specific cases. I’ll give you a general rundown here. If this sounds like it may include your business, then you can read the full details from the IRS.
- Food and laundry delivery drivers
- Life insurance sales agents
- Home craft assemblers
- Traveling salespeople
Home craft assemblers caught my attention. With the current trend towards hand made items, it’s possible some of you are working a craft business with independent assemblers out there. You’ll need to examine this issue closely!
Statutory non-employees include direct sellers and real estate agents. Once again, if this might apply to your organization, get the scoop from the IRS.
This article is part of the Small Biz 100, a series of 100 practical hands-on posts for small business people and solo entrepreneurs, whether in a small town, the big city, or in between. If you have questions you’d like us to address in this series, leave a comment or send us an email at becky@smallbizsurvival.com. This is a community project!
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Becky started Small Biz Survival in 2006 to share rural business and community building stories and ideas with other small town business people. She and her husband have a small cattle ranch and are lifelong entrepreneurs. Becky is an international speaker on small business and rural topics.
