As much as we may think we can handle a multitude of tasks in our business, the reality is that we need help to work efficiently and grow our companies. With the unemployment rate high, there are many talented workers that you can tap for the work you need done. How you set up the work arrangement can have important business and tax consequences, so do it right!

by BigIdeas4Biz

Your options
You can hire employees and grow your payroll, use independent contractors, or rely on temporary workers who report to you from agencies.

Practical considerations. If you foresee a continuing need for help, then hiring an employee is probably the way to go. You can train the person and develop employee loyalty. It doesn't make sense to hire someone only to fire him shortly thereafter; it's unfair to the employee and you'll needlessly hike your employment costs. If you only need someone for a special project or are unsure whether your business can make a long-term commitment to an employee, then consider using an independent contractor (IC) or turn to an agency for temporary help.

Cost. Having an employee is more costly than using an IC. With an employee comes an employer's obligations to pay the employer share of Social Security and Medicare (FICA) taxes, federal unemployment (FUTA) tax, state unemployment insurance and workers compensation. You also have to withhold income and FICA taxes from an employee's wages, include the employee in any health, retirement or other benefits program you maintain, and file returns with the IRS and states. In contrast, there are no tax payments or benefits obligations for a business that uses an IC. For a temporary worker, you pay the rate charged by the agency; there are no additional tax payments or benefits obligations on you.

Employee versus IC?
When engaging a worker, you can't arbitrarily put a label on the person to suit your needs. You can't call someone an IC and avoid employer obligations if they are really an employee. The IRS and states are on high alert to make sure you properly classify workers.
The IRS wants to be sure you are properly withholding taxes and paying your share of FICA as well as FUTA (federal unemployment tax).
States want to be certain you're paying state unemployment insurance and workers' compensation.
Proper classification of a worker turns on your degree of "control." If you have the right to tell the worker when, where, and how the work is to be performed, then the worker is probably your employee. While there is no single factor that nails down worker classification, here are some factors to consider:

Factors indicating employee status:
You can say when and where the work is performed (even if the person is working from his or her home).
You provide job training.
You dictate the order or sequence to follow in performing the work.
Your evaluation system measures the details of how the work is performed.
Factors indicating IC status:
The worker uses his or her own tools and equipment and purchases his or her own supplies.
The worker is allowed to hire assistants.
Your evaluation system measures the end results.

Note: A temp worker is the employee of the agency that arranges the placement with you. The agency, not you, has the employer's obligations.

Protect yourself
When you engage an IC, have him or her sign an independent contractor agreement to spell out the work relationship. The agreement is not a guarantee that the IRS won't question your arrangement, but it serves to remind the IC of his or her tax responsibilities.

Be sure to provide the IC with an annual information return, Form 1099-MISC (a copy of which is sent to the IRS). The return is required if payments for the year to an IC are $600 or more.

Be consistent with your treatment of workers. If ICs are doing the same work as people on your payroll, the ICs are probably employees too.

If, despite your best efforts, the IRS reclassifies your workers as employees, you can avoid tax penalties if you rely on "Section 530 relief" (the title comes from the section in the law that created it). There are no penalties as long as you provided the 1099s and had a reasonable basis for treating the worker as an IC. "Reasonable basis" means that it is common practice in your industry to treat such workers as ICs, there was a court decision or IRS ruling supporting your position, or you had a prior audit that did not change your worker classification.

Bottom line
Whether you're prepared to take on help now or anticipate doing so following an economic recovery, be sure to keep worker classification issues in mind. When in doubt, consult your tax advisor.