NFIB

Determine Independent Contractor Status Through Written Agreements
03/ 18/ 2003

by Jeffrey Moses

When small businesses hire independent contract workers, itÆs vital to establish written proof that the workers are indeed independent contractors and not employees. If the IRS or local tax authorities decide that a contract worker was actually classified as an employee of the company during the term of work, back withholding taxes and penalties may result. For this reason, itÆs wise to establish independent contractor status by written agreement at the beginning of the relationship.

The IRS determines the status of a worker either as an employee or an independent contractor based on a "right of control" determination. Speaking generally, workers may be classified as employees when the hiring company controls the way they work, where they work and when they work. Workers may be considered independent contractors when the company does not specify how, where or when they work.

To determine the type of relationship, the IRS also looks at whether workers:

1. Work for more than one company at the same time.
2. Pay for their own equipment, supplies, travel, training, assistants, etc.
3. Can potentially suffer a loss from the work.
4. Establish their working hours, place of work and style of work.
5. Are paid hourly or by completed project (independent contractors are often paid by the project--but this is not always the case).

To help establish independent contractor status, a written agreement should be completed between worker and hiring company that addresses each feature of these five points. Also include a detailed description of the project, what constitutes success of the project, the rate of pay, expected date for completion and notification that the hiring company has the right refuse finished work that is not acceptable.

Companies that frequently use outside contractors should consider drawing up a standard contractor agreement through an attorney. The agreement should specifically mention each of the above points. The contractor and an authorized representative of the hiring company should sign the agreement.

ItÆs important to note that the IRS, state and local government bodies often review each independent contractor situation separately--and in some cases may not agree on the determination for the same working relationship. By creating written agreements, however, the intent to establish independent contractor relationships is clear.

Drawing up a written independent contractor agreement also serves to establish the working and financial arrangement between the worker and hiring company. When an independent contractor knows exactly who pays for what, how success of a project is determined and when completed work is expected, many potential disagreements are removed.

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