The question I get asked most frequently from new clients is "what are the independent contractor rules?"  All small business owners like to use independent contractors to save money and avoid the dreaded payroll. 

The IRS and state agencies want to ensure that you are not misclassifying employees as independent contractors to get around employment laws and taxes. You must be sure you’re following the rules or you could face stiff penalties.  In the event worker’s are reclassified during an employment audit, you could be forced to pay all of the employment taxes owed from prior periods plus penalties and interest.  (and yes, they do regularly audit small businesses.  I’ve personally handled 2 audits in a two year period for my small client base.)

So, how do you know that you are classifying independent contractors appropriately?  Well, it’s not as easy as you would think.  The IRS and individual states employ different rules.  The general rule for any employment law is you must follow the most conservative law.  If the state’s laws are more stringent, you must follow state law…it’s usually the state that further clarifies a federal law.

The IRS publishes a 20 question test, http://www.toolkit.com/small_business_guide/sbg.aspx?nid=P07_1115.  You need to satisfy as many as possible to clear the independent contractor hurdle.  The most basic answer is – they must be "in business".  The person you are contracting to should: have more than one client, advertise their business, have the ability to hire and fire employees, and control their work.  In addition, you should have a contract with them.

What do you do if you have an independent contractor who is really an employee, but you don’t want to run payroll?  The easiest answer is to hire them through a staffing agency.  You’ll have to do some homework to find the agency that’s right for you. They will have a fee, but it’s much less if you just want to run your person through their payroll rather than asking them to recruit someone for you.  The other option is to utilize a PEO (professional employer organization) who will handle all payroll, benefits and HR issues for you.  I’ll be investigating PEO’s in the near future and will post my findings.

If you’re an Oregon employer, the bureau of labor and industry has a great site (http://www.oregon.gov/BOLI/) that answers many questions small business owners have regarding employment law.  I’ve also called them on many occassions for clarification on employment laws. 

For further reading on Oregon independent contractor rules, see: http://www.boli.state.or.us/BOLI/TA/T_FAQ_Taindocon.shtml. 

Kelly Totten, Acclaro Accounting