Many times when a business is first looking to expand, owners wonder whether they can hire someone as an independent contractor rather than an employee. Why? Hiring independent contractors is usually cheaper than employees. As we will discuss next week, hiring employees entails withholding taxes, paying the employer’s portion of FICA, purchasing worker’s compensation, paying unemployment insurance, complying with wage and hour laws, and the list goes on and on. However, when hiring an independent contractor, in most cases, someone only needs to pay the independent contractor and then file a 1099 with the IRS at the end of the year on what was paid to them.
The problem that arises when hiring independent contractors is that Colorado, the IRS, and the US Department of Labor may disagree with your conclusion that someone is an independent contractor and state that you have misclassified the person as an independent contractor and seek fines, penalties, and repayment of various amounts. For instance, if the Colorado Department of Labor determines that you have misclassified an employee as an independent contractor, you may be asked to repay all unemployment insurance premiums, fines, and penalties. If the IRS determines that you have misclassified someone, you may have to repay the employer portion of FICA.
So how do you determine whether you can hire someone as an independent contractor? Unfortunately, the IRS, the USDOL, and Colorado have three different standards. Typically, Colorado tends to be the strictest, finding more people are employees than either other entity. Colorado looks at two main factors:
- Is the independent contractor free from the business’s control and direction over how the independent contractor’s service are performed?
- Is the independent contractor customarily engaged in an independent trade, occupation, profession, or business related to the service he or she is performing for the business?
The CDLE In regards to the first, the CDLE looks at additional factors to determine whether someone is free from direction and control such as does the business or the independent contractor provide supplies? Who pays for mileage? Does the business train the independent contractor? In regards to the second question, the CDLE looks to see whether someone is truly running an independent business where they provide services to multiple companies or whether the person is more like an employee who only works for one company for a long time.
By looking at the whole picture, the CDLE is trying to figure out whether the relationship looks like an employee-employer relationship or one where the independent contractor is truly independent. If you are thinking about hiring independent contractors, make sure to speak with your accountant or attorney to go through the factors to determine that you are classifying the person correctly!