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Fearing the IRS


IRS & the Bogeyman

There is much fear and misconception about the IRS qualifications for an independent contractor (consultant). Many job shop agencies would have you believe that you cannot hire an independent contractor with impunity. That IS NOT TRUE! According to the latest information from the Bureau of Labor Statistics fully 6.7% of the workforce in this country are independent contractors .The IRS understands this and has rules to validate a worker's relationship with a company. The following is the pertinent section from IRS Publication 15-A 2003, dealing with independent contractors.


IRS Rules Excerpt (Pub 15-A)

  • Common-law rules
    To determine whether an individual is an employee or an independent contractor under the common law, the relationship of the worker and the business must be examined. All evidence of control and independence must be considered.
  • Behavioral control
    Facts that show whether the business has a right to direct and control how the worker does the task for which the worker is hired include the type and degree of—
    • Instructions the business gives the worker.
      An employee is generally subject to the business's instructions about when, where, and how to work. Even if no instructions are given, sufficient behavioral control may exist if the employer has the right to control how the work results are achieved.
    • Training the business gives the worker
      An employee may be trained to perform services in a particular manner. Independent contractors ordinarily use their own methods.
  • Financial control
    Facts that show whether the business has a right to control the business aspects of the worker's job include:
    • The extent to which the worker has unreimbursed business expenses.
      Independent contractors are more likely to have unreimbursed expenses than employees. Fixed ongoing costs that are incurred regardless of whether work is currently being performed are especially important. However, employees may also incur unreimbursed expenses in connection with the services they perform for their business.
    • The extent of the worker's investment
      An independent contractor often has a significant investment in the facilities he or she uses in performing services for someone else. However, a significant investment is not required.
    • The extent to which the worker makes services available to the relevant market.
    • How the business pays the worker
      An employee is generally paid by the hour, week, or month. An in-dependent contractor is usually paid by the job. However, it is common in some professions, such as law, to pay independent contractors hourly.
    • The extent to which the worker can realize a profit or incur a loss.
      An independent contractor can make a profit or loss.
  • Type of relationship
    Facts that show the parties' type of relationship include:
    • Written contracts describing the relationship the parties intended to create.
    • Whether the business provides the worker with employee-type benefits, such as insurance, a pension plan, vacation pay, or sick pay.
    • The permanency of the relationship
      If you engage a worker with the expectation that the relationship will continue indefinitely, rather than for a specific project or period, this is generally considered evidence that your intent was to create an employer-employee relationship.
    • The extent to which services performed by the worker are a key aspect of the regular business of the company.
      If a worker provides services that are a key aspect of your regular business activity, it is more likely that you will have the right to direct and control his or her activities. For example, if a law firm hires an attorney, it is likely that it will present the attorney's work as its own and would have the right to control or direct that work. This would indicate an employer-employee relationship.

Industry Examples (still from Pub 15-A)

The following examples may help you properly classify your workers.

Computer Industry

Example. Steve Smith, a computer programmer, is laid off when Megabyte Inc. downsizes. Megabyte agrees to pay Steve a flat amount to complete a one-time project to create a certain product. It is not clear how long it will take to complete the project, and Steve is not guaranteed any minimum payment for the hours spent on the program. Megabyte provides Steve with no instructions beyond the specifications for the product itself. Steve and Megabyte have a written contract, which provides that Steve is considered to be an independent contractor, is required to pay Federal and state taxes, and receives no benefits from Megabyte. Megabyte will file a Form 1099–MISC. Steve does the work on a new high-end computer which cost him $7,000. Steve works at home and is not expected or allowed to attend meetings of the software development group.

Steve is an independent contractor.


Example. Donna Yuma is a sole practitioner who rents office space and pays for the following items: telephone, computer, on-line legal research linkup, fax machine, and photocopier. Donna buys office supplies and pays bar dues and membership dues for three other professional organizations. Donna has a part-time receptionist who also does the bookkeeping. She pays the receptionist, withholds and pays Federal and state employment taxes, and files a Form W–2 each year. For the past 2 years, Donna has had only three clients, corporations with which there have been long-standing relationships. Donna charges the corporations an hourly rate for her services, sending monthly bills de-tailing the work performed for the prior month. The bills include charges for long distance calls, on-line research time, fax charges, photocopies, mailing costs, and travel, costs for which the corporations have agreed to reimburse.

Donna is an independent contractor.


You can see that there is a lot of flexibility and there is room for special circumstances. If the scope of a project cannot be determined or is changeable, an hourly billing is acceptable. If, because of hardware facilities or security reasons, the project must be done on site, it still works.