Starting a Very Small Business - Part 7 - Independent Contractor or Employee?

As I have been talking with my sister Carol about setting up her small business (selling antiques/collectibles at an antique mall), we have talked about her "hiring" her daughter Cindy to do some of the bookkeeping and inventory management. This weekend, we spent some time talking about whether Cindy should be an independent contractor or an employee.

This is a tough decision, and one I get asked about a lot. There is a good deal of confusion about this subject, because the circumstances vary so much, and the lines between employee and independent contractor are blurred. One thing to remember is that the IRS considers someone an employee, unless it can be proven that the person is an independent contractor.

In this case, Cindy also does some medical coding for people, so she has another "independent" business, and she also has some experience with Excel. Carol would pay Cindy by the hour, and she would rely on Cindy to do the work accurately, using her expertise.

We reviewed the three key areas that the IRS uses to evaluate whether a worker is an independent contractor or an employee:

• Behavioral Control.
  Does Carol train Cindy in how to do the work, and does she require her to do the work in a specific way?
  
  
• Financial Control
  Does Cindy have an investment in the company? Does Carol pay her expenses or does she pay her own?
  
  
• Relationship of worker to the company
  Does Cindy work for other companies? Is there a written contract specifying her as an Independent Contractor?

Another way to look at this that I use (I didn't get this from the IRS, so don't rely on it, please): Is the worker doing work that is core to the business, or supplemental? For example, if you hire someone to work in your store as a salesperson, that's core. If you hire the person to clean the store, that's not core, it's supplemental..

For more information, check out IRS Topic 762. You can also get a determination from the IRS by filing IRS Form SS-8. You will need to attach a copy of any contracts, and there is a special section with questions about salespeople.

The presence or absence of a contract is not the determining factor. I have known businesses that had workers sign contracts that designated them as an "independent contractor," but the IRS still said the workers were employees.

As I said, this is a very tricky area, and the IRS and state employment agencies can impose fines and penalties if you mis-classify a workers. Get an attorney who specializes in this area, if you are in doubt. Have the IRS make a determination. Or, better yet, make the person an employee.