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During the past 4-5 years, many of my clients have been laid off from their corporate jobs, only to be re-hired as independent contractors, consultants or free-lancers. This is cost-effective for the company, which is no longer paying benefits and employment taxes on the employee.

But companies need to be careful when hiring contractors and setting up the engagement structure. Just calling someone an “independent contractor” does not mean the person is a contractor and not an employee for Internal Revenue Service purposes. And if the IRS audits, a company that has mis-characterized a worker can face significant fines and penalties for failure to pay and withhold payroll taxes.

The IRS has significant guidelines on the difference between contractors and employees. The key issue is whether the company directs or controls the means and methods of producing the work, or just gives the contractor the job specifications and timelines and receives the results from the contractor. The more the company directs the sequence of how the work is performed, the more likely the contractor will be characterized as an employee. Other factors the IRS will consider are who provides the tools/supplies, where the work is done (at the company or at the contractor’s place of business) and whether the contractor has other clients.

Another downside to hiring contractors instead of employees is that you may not be their only client, and it may be difficult to schedule your projects.

Before you hire someone as a contractor, particularly if you are replacing an employee with a contractor, you should talk with your accountant and attorney about the nature of the work, the frequency of the work and the way in which the work is going to be performed.

After you set up the structure, a good enagement agreement is essential to set out the work specifications, timing, payment amounts and times, liability, insurance and ownership of work product. Companies generally assume that because they are hiring someone to create work product for them, they will automatically own the work. While employee work almost always is owned by the company, this is not often the case with a contractor.

Tags: benefits, consultant, contractors, control, free-lancer, freelancer, independent contractors, Internal Revenue Service, IRS, Payroll Taxes, penalties

This entry was posted on Tuesday, June 2nd, 2009 at 9:54 am and is filed under business law, Contracts, economy, employment law, Uncategorized. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.