Employee or Independent Contractor?
Know the Differences this Tax Season for ACA Purposes
By Jim Gerhard
Businesses have long utilized independent contractors as a means of leveraging the highly trained services of other professionals. Independent contractors provide their own tools, training and expertise. This saves the hiring company the cost of teaching someone how to do the job. Additionally, because contractors aren’t full-time employees, the hiring companies don’t have to worry about withholding income, FICA or Social Security taxes from their wages. When the work is done, the hiring company simply pays the agreed-upon fee, and both parties go on their way.
But are contractors always independent? The Affordable Care Act has given this already important question a renewed sense of urgency.
As outlined in the Affordable Care Act, companies that employ 50 or more full-time workers are required to make affordable health insurance available to their employees. The ACA defines an employee as anyone working a minimum of 30 hours a week. But be careful, as the hours of part-time employees can be combined to create their “full-time equivalent.”
Perhaps you think your business is exempt from providing such coverage, as you either don’t satisfy the minimum requirements, or because you rely on independent contractors in lieu of full- or part-time employees. That may be the case, but beware: The IRS may disagree. The Service may decide to take a closer look at your company and, upon inspection, rule that the workers you thought were independent are really employees in disguise.
If the IRS were to reclassify your workers, you could be required to provide health insurance and potentially be subject to fines and penalties. All in all, a costly and avoidable consequence.
Below are a few examples illustrating the difference between employees and contractors, as well as circumstances that may inadvertently convert an independent contractor into an employee.
Who’s in control?
Let’s say you hire an independent contractor to fix your furnace. An independent contractor would estimate when he or she could begin the work, as well as provide an estimated timeline for its completion. He or she decides things such as when to break for lunch and what tools to use. It is accepted that the contractor is already an expert in his or her field, and no employer-sponsored training is required. By dictating the “when” and the “how” in regard to the project’s performance, the contractor is displaying the characteristics of independence.
Conversely, employees generally perform their duties at the discretion of their employers. In the example above, by dictating what time the contractor should take lunch, or providing the tools and training necessary to complete the task, the company could inadvertently convert the worker from contractor to employee.
Long-term or project-based?
In the previous example, the contractor is obligated to fix the furnace. Once that project is complete, his or her commitment to you is satisfied. Of course, you are free to contract with that person again as many times as you’d like, but, unlike employees, the independent contractor has no reason to expect continuous or recurring employment with your firm.
This is an important distinction, as we have seen some confusion as it pertains to seasonal help. Please note: seasonal workers are generally considered employees. The seasonal nature of the work is considered to be recurring (even though not continuous). When not working, the seasonal help can be considered on call, another important indicator of an employee/employer relationship.
A life of independence comes at a cost, and that cost is usually the comfort of a steady paycheck. Independent contractors are in business for themselves. As such, they forego the certainty of steady pay in search of unlimited income. As they’re in business for themselves, they also stand to profit (or loss) in direct proportion to the performance of their company.
Many people are uncomfortable with that type of risk, so they opt for a job and steady pay. Few things point to employee status quite like a steady paycheck. If your business has hired a contractor for a large project and has chosen to pay that person on a fixed, regular basis (hourly, weekly, monthly), there is a chance the IRS would consider that person an employee.
Your full-time employees likely only work for you, while independent contractors are expected (in fact, encouraged) to have other clients or customers. Consequently, if you are paying someone as an independent contractor but you are the only source of income for that contractor, the IRS may consider the contractor to be an employee.
If you find yourself wondering if any of this applies to you, contact your CPA. That call could be your most valuable investment.
Jim Gerhard, CPA, is a senior associate in the FWRD Group at Wiss & Company LLP. Reach him at firstname.lastname@example.org or 973.994.9400.