Independent contractor

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An independent contractor is a natural person, business, or corporation that provides goods or services to another entity under terms specified in a contract or within a verbal agreement. Unlike an employee, an independent contractor does not work regularly for an employer but works as and when required, during which time he or she may be subject to law of agency. Independent contractors are usually paid on a freelance basis. Contractors often work through a limited company or franchise, which they themselves own, or may work through an umbrella company.

In the United States, any company or organization engaged in a trade or business that pays more than $600 to an independent contractor in one year is required to report this to the Internal Revenue Service (IRS) as well as to the contractor, using form 1099-MISC.[1][2] This form is merely a report of the money paid; independent contractors do not have income taxes withheld like regular employees.

Independent contractor versus employee[edit]

The distinction between independent contractor and employee is an important one in the United States, as the costs for business owners to maintain employees is significantly higher than independent contractors due to the need to pay social security, Medicare and unemployment taxes on employees.[3]

In the early 1990s, the IRS methodically began to look for employers who were misclassifying employees as independent contractors, and has since obtained billions of dollars in Social Security back taxes.[3] Recently, worker classification initiatives have been a top priority for the IRS, the Department of Labor, and state agencies. In 2011, the IRS and the Department of Labor entered into a memorandum of understanding in an effort to jointly increase worker misclassification audits.[4]

The United States Supreme Court has offered the following guidelines to distinguish employees from independent contractors:

  1. The extent to which services are integral to the employer's business. Greater integration favors an employee-employer relationship.
  2. The permanence of the relationship. More established relationships favor employee status.
  3. The amount of investment in equipment. More investment suggests an independent contractor relationship.
  4. The degree of control by the principal. More control favors employee-employer status.
  5. The amount of financial risk. More opportunity for profit or loss favors an independent contractor relationship.
  6. The amount of initiative, judgment or foresight in open-market competition with others required for the success of the claimed independent enterprise. Entrepreneurial and distinctive work favors an independent contractor relationship.

The IRS, for federal income tax, applies a "right to control test" which considers the nature of the working relationship.[5] They highlight three general aspects of the employment arrangement: financial control, behavioral control, and relationship between the parties. In general, their criteria parallel those of the supreme court in sentiment. They include guidelines such as the amount of instruction, training, integration, use of assistants, length of professional relationship, regularity of work, location of work, payment schedule, source of funds for business expenditures, right to quit, and financial risk more typically seen with each work category. In their framework, independent contractors retain control over schedule and hours worked, jobs accepted, and performance monitoring. They also can have a major investment in equipment, furnish their own supplies, provide their own insurance, repairs, and other expenses related to their business. They may also perform a unique service that is not in the normal course of business of the employer. This contrasts with employees, who usually work at the schedule required by the employer, and whose performance the employer directly supervises. Independent contractors can also work for multiple firms, and offer their services to the general public.[3]

The distinction between independent contractors and employees is not always clear, and continues to evolve. For example, some independent contractors may work for a number of different organizations throughout the year, while others retain independent contractor status although they work for the same organization the entire year. [6] Other companies, for example in the freight transport industry, specify the schedule for the independent contractor, require purchase of vehicles from the company and prohibit work for other companies.[7]

Specific occupations[edit]

Examples of occupations where independent contractor arrangements are typical:

Advantages and disadvantages[edit]

Independent contracting has both benefits and hindrances.

Advantages[edit]

  • Since they are rarely tied to an employer, they are free to set their own rules of business, limited only by bargaining power.
  • Since they usually develop a large network of clients, the loss of one or two often has a negligible effect.
  • Many people simply like the idea of "being your own boss." Aside from materialistic benefits, many people simply enjoy not having to answer to a supervisor.
  • As an artist/author of any tangible artwork, such as paintings, sculptures, photographs, or written works, a person is entitled to exclusive copyright ownership if they created the work as an independent contractor. If the person created such works while in the employ of another person or corporation, the rights belong to the employer (under most standard employment contracts).

Firms in the sharing economy such as Uber can gain substantial advantages by classifying associates as independent contractors.[8]

Disadvantages[edit]

  • In the United States, an IRS computer algorithm matches individuals with 1099 forms to the company that pays them. If an independent contractor reports more than $10,000 of earnings, or majority of income, from a single source, the IRS is likely to question the independence of the worker, and investigate the company that issued the 1099 form.[3]
  • Employer misclassification of employees as "independent contractors," either inadvertently or to avoid taxation and regulation, is widespread.[9] Additionally, contractorization has been used as an indirect form of union-busting.[10]
  • An independent contractor can itself be a business with employees; however, in most cases in the United States independent contractors operate as a sole proprietorship or single-member limited liability company. This means the independent contractor, as a business owner, incurs its own expenses to provide the contracted service, must acquire its own equipment to perform the service, and is responsible for business filings such as income tax returns.[11]
  • Independent contractors are responsible for their own self-employment tax, which consists of both halves of the FICA tax amount.[12] An employee only pays the employee portion of the FICA tax. Self-employment taxes are not withheld from the earnings of independent contractors who are required to voluntarily declare and pay estimated earnings taxes to the IRS, which can lead to a trap for contractors who run into financial difficulty and become tempted to put off making the required estimated tax payments.
  • There are several monetary incentives that are guaranteed to employees in the United States, but not independent contractors. Examples include worker's compensation and unemployment insurance; however, independent contractors are allowed to make Individual Retirement Account contributions.
  • In many jurisdictions, occupational safety and health regulations are less comprehensive for independent contractors.[13]

Independent contracting in tort[edit]

The employer of an independent contractor is generally not held vicariously liable for the tortious acts and omissions of the contractor, because the control and supervision found in an employer–employee or principal–agent relationship is lacking. However, vicarious liability will be imposed in some circumstances:

  1. where the contractor injures an invitee to the real property of the employer,
  2. the contractor is involved in an ultra-hazardous activity (one likely to cause substantial injury, such as blasting with explosives), or
  3. the employer is estopped from denying liability because he has held out the independent contractor as if he were simply an employee or agent.
  4. the employer is involved in an operation subject to obligations imposed by a public authority

Alternatives to independent contractors[edit]

Due to the higher expense of maintaining employees, many employers needing to transition to independent contractors may find the switch to contracting difficult. There is a transitional status for employees as an alternative to independent contracting known as being a statutory employee. Statutory employees are less expensive to hire than classic employees because the employer does not have to pay unemployment tax. However, they are more expensive than independent contractors because Social Security and Medicare taxes must be paid on wages. Similarly to independent contractors, statutory employees can deduct their trade or business expenses from their W2 earnings.[3]

See also[edit]

References[edit]

  1. ^ See generally 26 U.S.C. § 6041 and 26 C.F.R. sec. 1.6041-1.
  2. ^ Sample form 1099-MISC [1]
  3. ^ a b c d e Brabec, Barbara (November 26, 2014). How to Maximize Schedule C Deductions & Cut Self-Employment Taxes to the BONE -. Barbara Brabec Productions. p. 107. ISBN 978-0985633318. 
  4. ^ Koch, Matthew (6 June 2014). "The Tax Risks of Misclassifying Employees". The National Law Review (McBrayer, McGinnis, Leslie and Kirkland, PLLC). Retrieved 14 June 2014. 
  5. ^ McConville, Timothy M. (20 May 2014). "Don't Misclassify Workers as Independent Contractors". The National Law Review (Odin, Feldman & Pittleman, P.C.). ISSN 2161-3362. Retrieved 14 June 2014. 
  6. ^ IRS Frequently Asked Questions about form 1099-MISC [2]
  7. ^ Koch, Matthew (6 June 2014). "The Tax Risks of Misclassifying Employees". The National Law Review (McBrayer, McGinnis, Leslie and Kirkland, PLLC). Retrieved 14 June 2014. 
  8. ^ Lauren Smiley (April 20, 2015). "What Strippers Can Teach Uber" (Medium.com). Retrieved April 21, 2015. Many of these companies are built with workers who are not even considered workers at all. In a twist of business logic that drives much of the sharing economy, these delivery people, drivers, and maids aren’t employees – they’re entrepreneurs. 
  9. ^ "U.S. Cracks Down on ‘Contractors' as a Tax Dodge" article by Steven Greenhouse in The New York Times February 17, 2010
  10. ^ Salon - Taxes for union busting
  11. ^ Radio New Zealand - Truck drivers to lose jobs
  12. ^ See definition of FICA Tax.
  13. ^ Times-Standard - Logger deaths highlight safety concerns; contractors exempt from state guidelines

External links[edit]