As business owners, sometimes we tend to hire employees on a part-time basis for short-term projects, or at times outsource the work to another individual or company, depending upon whichever choice is more cost effective. However, such decisions also have a tax impact, and the US Internal Revenue Service (IRS) requires certain conditions to be fulfilled for a hired person to be considered either a full-time employee, a part-time employee, or an independent contractor for income tax purposes.
At AG Tax, while preparing the tax returns for some of our clients, we noticed that some independent contractors were actually part-time employees, or vice-versa, thus resulting in an incorrect tax treatment. To assist in preventing this, we have prepared a brief overview of the conditions to be fulfilled for an independent contractor to qualify as one.
Nonetheless, it is always good practice to consult your tax advisor or practitioner before proceeding with hiring an independent contractor to confirm if all the parameters have been met. Misclassifying an employee as an independent contractor or vice versa can lead to fines and penalties, even if it is a mistake.
Independent Contractor as per IRS
As per the IRS, any individual providing services to another business simultaneously, and working with a profit motive, with full authority and control over how to complete the work is considered an ‘independent contractor, and subject to self-employment taxes.
The business that hires a contractor does not deduct any federal tax withholding, or Medicare and social security taxes, or provide any pension or other such benefits to the contractor.
Generally, consultants, such as accountants, computer technicians, or lawyers work as independent contractors.
Differentiating Between an Independent Contractor & Part-time or Full-Time Employee
For an individual to qualify as an ‘independent contractor, the following conditions must be fulfilled:
- Multiple Projects during the Year: The individual should have worked on various projects during the year, and should be hired by different employers rather than just one project or many projects for one employer; situations may vary in case of long-term projects.
- Client Base: The contractor should have more than one client. It is possible that they may work for one client more than once, but care should be taken that the projects are not regularly and frequently from only one client.
- Issue Invoice/Bill the Client: The person should issue an invoice to the client separately for every project completed.
- Investment: Generally, all the expenses incurred or payments made to assistant(s) should be taken care of by the contractor, and equipment used should be self-owned, or if such expenses are borne by the client, it should be properly clarified in the agreement between the two parties.
- Possibility of Loss: Since the individual is working on a project basis, there should be some risk factor regarding the payment, unlike an employer-employee relationship, where a payment, in the form of salary, is confirmed, and there is little risk of loss.
- Right to Control and Make Decisions: The client may interfere at times regarding the outcome,however, the working method and timing should be decided by the contractor. It is not necessary for them to report every step to the client unless requested by the client.
The contractor should not be receiving instructions on how to complete the work by the client, nor should the client be providing any training to the contractor. Basically, the contractor should look self-employed rather than an employee of a company. If there is still confusion regarding the classification of an employee or contractor, the client company or the contractor may file Form SS-8, Independent Contractor or Employee, so that the IRS may help confirm the worker’s status.
A business owner hiring a contractor should have the terms and conditions properly outlined in the agreement, and have it reviewed by their tax practitioner and attorney to avoid any errors, since as mentioned above, improper classification of employees can lead to severe penalties.
AG TAX LLP Can Help
If you have any tax-related queries, need assistance with tax planning or filing your tax returns please contact us. Our team comprises of highly experienced tax professionals with extensive knowledge of U.S. and Canadian tax laws as well as cross-border compliance.
Furthermore, as a full service accounting firm, AG Tax assures complete assistance with even your most complex tax needs.
We can assist with:
- Canadian Personal and corporate tax returns
- Cross Border Taxation and Business Planning
- U.S. Personal and Corporate Taxation
- Disclosure of Foreign Assets and other information filings
- Retirement planning
- Estate Planning, Inheritance tax advice
To obtain a quote or to arrange for a consultation to discuss your tax related queries, please contact us at:
- 416-238-5920 (Greater Toronto Area, ON)
- 604-538-8735 (Greater Vancouver Area, BC)
- 780-702-2732 (Greater Edmonton Area, AB)
Disclaimer: The information in this publication is accurate as of the time of its publication. AG Tax assumes no responsibility for changes to tax legislation subsequent to the publication of this document. The information provided is for general information purposes only and should not be acted upon without seeking professional advice. If you would like to engage our services, please contact our staff and obtain authorization to send our firm confidential information. A client relationship is not created by the transmission of information. A client relationship is only formed with our firm when a scope and engagement letter signed by the firm and the potential client detailing the terms of engagement is present.
