Independent Contractors: Taxation and Liability – Most Common Issues

With almost one in ten people still jobless in the U. S. , many unemployed workers are turning to independent contractor work, bringing new opportunities – and challenges – to American workplaces.

These alternative arrangements offer both employers and contractors added flexibility and oftentimes financial benefits they couldn’t derive through traditional employer-employee relationships. But they also bring some challenges that need to be addressed in order to protect both parties. The majority of those issues center on taxation and liability.

Employers must withhold income taxes on employees’ compensation and pay 50 percent of the employees’ payroll taxes. Independent contractors pay their own income tax and 100 percent of their payroll taxes. If a person fails to pay these taxes, the Internal Revenue Service will seek payment from the business if they perceive the person to be an employee. But if it’s clear that the worker is an independent contractor, the business can’t be held responsible.

Likewise, businesses may be liable for the actions of employees when acting on behalf of employers; whereas independent contractors are liable for their own actions. That means if someone causes injury or property damage on the job and he or she is your employee, your business can be held liable and the injured party can seek reimbursement or damages from you and your insurance company.

But if that person is an independent contractor, he or she – and his or her insurance company – will be responsible for damages.

Further, if an employee is injured on the job, the company may be responsible for any worker’s compensation claims as a result of the injury. That’s not the case if the worker is an independent contractor.

Clearly, it’s important to understand the differences between employees and independent contractors, and respect the delineation. The IRS and courts primarily look at three factors when distinguishing the difference: behavior, finances and nature of relationship.

Workers are more likely to be viewed as independent contractors when they have

  • a separate business entity such as a corporation;
  • a written contract with the company that defines the relationship (not an employment agreement); and
  • other accounts in addition to the subject company.
  • Conversely, workers are more likely to be viewed as employees when the company
  • requires the worker comply with instructions about when, where and how the work is to be performed;
  • the company provides training for the worker;
  • the company requires the worker to perform services personally as opposed to subcontracting labor; and
  • the company provides compensation or benefits that look like those of an employee’s.

When you consider hiring someone, it’s safest to decide up front whether that person will be an employee or an independent contractor based upon the true nature of his or her relationship with your company. Then stick with that decision.