By Mary Dunlap, CFP®, and Debra M. Girvin
For financial planning practices, that may mean taking a closer look at hiring an independent contractor or hiring an employee. Both situations have pros and cons, and financial planners are often looking for guidance on making the best hiring decision.
Understanding how the Internal Revenue Service and state regulators classify independent contractors and employees will help you determine who to hire so you don’t waste thousands of dollars, end up dissatisfied, deliver poor results to clients or risk government penalties from audits.
Government audits are no joke. States routinely check employment records, inquiring about whether a worker is functioning as an independent contractor or an employee. Often times, invoices and other records must be produced to justify an employee’s status. What’s the probability you will get audited? Who knows? What is the probability you will have a lot of work and worry putting records together for an audit? How about 100 percent! That’s why it pays to be prepared from the get-go.
For many small business owners, powerful motivations exist for hiring independent contractors.
Assuming you found the right contractor who can deliver what you need, you won’t be training or developing this person. You also won’t pay for benefits, including health and disability insurance, vacation time, sick days and retirement plans-benefits that can cost anywhere from 20 percent to 40 percent of a person’s salary.
By hiring an independent contractor, you also won’t pay the employers’ share of Social Security and Medicare taxes, which are 7.65 percent of compensation, and you won’t contribute to state and federal unemployment insurance funds, which can be 2 percent or more of compensation depending on the state.
Independent contractors are not subject to many laws designed for employees, including overtime and minimum wage requirements. By hiring an independent contractor, you won’t be subject to complaints for wrongful termination.
While it seems that you may not be liable for an independent contractor’s actions, you do have a fiduciary responsibility to hire an independent contractor to complete work in an ethical, legal and compliant manner.
You should also consider the potential downsides of hiring an independent contractor. In general, using an independent contractor assures less control of the process and the resulting end product to you, the business owner, and more control to the independent contractor. And using an independent contractor may not always provide a significant cost savings versus hiring an employee when you consider the higher fees a contractor may charge to do a specific job.
Also, you may not get possession of intellectual property that is generated as a result of the work. For example, programs, spreadsheets or documents could remain property of the independent contractor, and he or she could charge you for use of the materials.
You may find that you want and need to control the process and the people, and not just pay for the results. In that event, you may be better served by hiring an employee.
Keep in mind that you can hire an independent contractor, and then bring that person on as an employee later, as your business needs change. However, you should consult with an expert on how to do this successfully.
Hiring an independent contractor should not be done lightly. Many business owners assume that someone qualifies as an independent contractor if the person has what he or she calls their own business and does work for other firms, can bill for their services and can work independently.
However, the definition of an independent contractor is not that simple.
Here is a general list of what federal and state agencies such as the IRS, state revenue departments, and state and federal unemployment agencies look at when classifying workers as independent contractors. This list does not detail everything; you should consult an attorney and human resource expert for more guidance in your specific situation.
Independent contractors are responsible for the materials and equipment to get your work done. The more an independent contractor works on your equipment and uses your materials, the more it shows a lack of investment the contractor has in his or her own business-more signs of an employee status. This is not to say that an independent contractor cannot work on your equipment. For example, a computer consulting firm needs to work on your computers, but it is obvious that a legitimate firm has its own equipment and office(s).
Incorrectly classifying a worker can lead to a variety of penalties, ranging from 15 percent to more than 40 percent of worker compensation for the effective time period. You could also incur penalties for not collecting Social Security payments.
The IRS also looks to see if you intentionally misclassified workers to avoid certain levels of compensation from being considered in retirement plan contributions. As a result, your retirement plan could lose its tax qualified status.
Overall, to be sure you make the right kind of hire-either an independent contractor or an employee-assess what you need in terms of control, training and length of job. And when hiring an independent contractor, always keep good records of work agreements and invoices.
Mary Dunlap, CFP®, of Mary Dunlap Consulting, helps financial planning firms attract, develop and retain the best people for their teams. She is a member of the Society for Human Resource Management. Contact her at firstname.lastname@example.org.
Debi Girvin, SPHR – Lochlyn Company. Debi has worked in Human Resources and Benefits Management since 1985. Lochlyn Company is a human resource consulting and outsourcing firm with clients in Virginia, New York, Pennsylvania, Maryland, Delaware and Washington DC. Her work in Human Resources has included being a member of the planning and start-up teams for a multi-million dollar grassroots manufacturing facility and developing a corporate Human Resource department for an internet start-up company. Debi is a member of the Society for HR Management (SHRM)
This article is for informative purposes only and is not to be construed as legal advice.
My team and I are dedicated professionals who through honesty, caring and desire, provide our clients the tools and processes for sensible, appropriate human resource management, for recruiting the right person for the right job, for coaching people to do better and to direct energies for increased business and personal results.