Copyright 2006 Bookkeeping R Us All Rights Reserved
You may be thinking that someone is a subcontractor because you pay them by a check or cash without withholding payroll taxes. But that is not how the IRS sees it. According to the Internal Revenue Service an employee is defined as anyone who performs a service that is subject to the will and control of an employer. If you are laying down the rules as to what will be done and how it is to be done, then you have an employer/employee relationship and must by law withhold income taxes.
Now there are many business owners that do not understand this and risk penalties and fines as well as being responsible for your “employee’s” non withheld income taxes, social security and Medicare taxes. This can add up to large amount of money. So if your business is one which often uses subcontractors, you might want to review your policies in this area. The government often conducts “employee audits” within industries that fall into this category.
So what is an employee audit? The IRS will send in an agent to review your payroll records and subcontractor payments. Persons being paid as subcontractors could be reclassified as employees if they do not meet certain requirements. Some, but by no means all, of the criteria the agent will be looking for are as follows:
Does the subcontractor only work for you – or do they have other clients?
Do they provide their own tools, work space?
Do they set their own hours?
Is the work they perform, how and when it is done determined by them?
Do they have a business phone, business cards, and printed billing forms?
Do they have a legitimate place of business (a real office for example)?
Do they advertise?
Do they have employees being paid as employees?
Do they have business insurance?
Ignoring this risk may seem the easiest and most cost effective way to do business, but if you are audited, you will wish you had followed the rules. If you think you might be in a gray area, then give your accountant a call so they may review your situation and make recommendations. And for more information see the IRS Article “Independent Contractors vs. Employees.