Independent contractors open up doors for businesses. When a business can’t afford to hire a full-time employee because of added costs like payroll costs, benefits, unemployment, and social security and Medicare taxes, independent contractors provide a low-cost way of getting skilled work. They can be a source of special skills that are needed only occasionally or a way to support your regular team during busy times. Some businesses also use independent contractors as a way of getting the work they need to be done without creating nexus in a new jurisdiction. However, the line between employee and independent contractor is tricky and businesses need to be aware of where their workers fall.

If the IRS decides that a worker who was hired as an independent contractor is actually an employee, you’ll not only have to clean up a big financial mistake for payroll but also possibly have to start collecting or paying sales tax in the jurisdiction where the independent contractor is working. So how do you tell the difference? The best advice is to always consult a CPA, attorney, or employment expert for a definitive answer. They usually look at the three following areas:

  • Behavioral control
  • Financial control and
  • Relationship of the parties.

Depending on how you handle your independent contractors, they might actually be deemed employees.

The IRS has a 20-point test they use to determine employee status. Many businesses think of independent contractors as people who work outside of the company on their own equipment, but it’s much more complex than that. For example, if you set your workers’ hours, directly oversee their work, and require them to wear uniforms, you probably have employees rather than contractors. If you use independent contractors, it’s a good idea to review your worker’s processes regularly to ensure that you’re not crossing that line into an employer/employee relationship. Thirty-five states have confirmed that telecommuting across state lines can create nexus for the employing company, so the sales tax consequences can be severe.

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