20 May Employee or Subcontractor?

Are the people that work with your business subcontractors or employees?

This a question that many businesses face today.  It may be a difficult question to answer.  But rest assured that your state and local agencies and the federal government are interested in how you answer that question.

If you answer it wrong, you may face paying penalties, interest and both the employer and employee side of the social security and medicare payroll taxes.

How do you determine if a worker is an employee or a subcontractor?

The first test is one of Behavioral Control

• Do you provide training or instruction on how to perform the work?
• Do you determine the methods for how the work is completed?
• If the worker encounters problems with completing the work do they report to you for solutions?
• Is the worker required to work a specific schedule, hours or days?

The second test is one of Financial Control

• Do you supply the equipment, materials or other property to complete the work?
• Does the worker use your facility, office or warehouse space during the work completion?
• Do you pay the individual a salary, commission, or hourly wage for the work completed?
• Do you establish the cost of the services or products provided by the worker?
• Do you reimburse expenses such as mileage, supplies, telephone, internet, etc to the worker?
• Does your company insure the worker for workers compensation?

The third test is one of Relationship 

• Do you provide benefits such as paid vacation, sick leave, holiday pay, personal days, or pension benefits?
• If you terminate the relationship with the worker do you risk liability or penalty?
• Is the worker providing the products or services exclusively to your business?
• Do you represent the worker to your customers under your business name?

While no single question, or group of questions, provides absolute definition of a subcontractor vs an employee, if you answered affirmatively to the questions above then the classification steers towards employee.

What factors define a subcontractor?

Some of the factors that more clearly define a subcontractor include:

• Worker is part of another business entity such as a corporation or LLC that you have engaged to do the work.
• Written engagement letter or contract providing the scope of services and/or products with a specific purchase price.
• Work is performed using tools, equipment and other property owned and provided by the worker’s company.
• Methods of providing the work are set by the worker/worker’s company.
• Worker provides services or products to businesses other than your own.
• You do not set the hours or schedule of the worker.
• Worker maintains a separate place of business outside of your business address.

Benefits of Subcontractors Classification

There are many reasons why a business would prefer to classify a worker a subcontractor and not an employee.  One reason is to save payroll taxes.  Payments to subcontractors are not considered payroll so the business does not have to pay the employer portion of social security or medicare.  The employer would also not have to pay federal and state unemployment or be subject to unemployment rate increases if the person no longer works with the company and claims unemployment.

Another benefit of using subcontractors versus employees is subcontractors do not get paid benefits including overtime pay, vacation and sick leave, pension contributions and health insurance.  The business is also not obligated to participate with government programs such as the Family and Medical Leave Act or Affordable Care Act.  Your company saves training or recruitment expenses.

Factoring in all these benefits, the cost savings of subcontracting goods and services can be substantial.  Not to mention the depth and breadth of the expertise provided by the company specializing in the services or products you need.

Benefits of Employee Classification

With all the benefits of using subcontractors why would you want to hire an employee?

The reasons are many and varied depending on the type of business.  Here are some of the reasons:

• Your business needs a service or product that is proprietary to your business.
• Your business requires workers to work specific hours or days.
• The work you need completed requires equipment or tools you provide or to be completed in your facility.
• Your customers or clients come to your place of business to interact with your employees.
• Your workers require specialized training to complete the work to brand standards.

TBooks would be happy to help you determine if your business has engaged a subcontractor or hired an employee!  Feel free to contact us for a free consultation.

For more information check out this link to the IRS website:
http://www.irs.gov/Businesses/Small-Businesses-&-Self-Employed/Independent-Contractor-Self-Employed-or-Employee