We as managers often are seeking whether to outsource labor or bring it in-house in the form of an employee. Some positions in our office seem to be a natural when it comes to us choosing whether to take on the headache and additional overhead of an employee or to hire a contractor. When you make the decision to hire the contractor instead of an employee, make sure you are truly hiring a contractor per IRS regulations and that you aren't setting yourself up for an unfavorable IRS payroll audit.
Contractors as defined by the IRS have to have certain characteristics to qualify for the treatment as a contractor instead of an employee. You might be able to save some short term headaches by not having to process a payroll check, add on benefits, etc., but the results of treating an employee as a contractor can be a long term headache with real steep monetary costs. You can draw up a contract with the person, pay them as a contractor and report it on a 1099, but still end up with several years of withholding tax liability and penalties if the person is not truly a contractor as defined by law. You may also be held liable for pension expenses for the person if your business has a pension plan. A couple of other points to note - the IRS often will not go after the individual as to the payroll taxes due - they usually always go after the employer. With the president's 2012 budget proposal including tougher IRS enforcement of what is now often characterized as the contractor-versus-employee "loophole," the threat of a payroll tax audit will be higher for our businesses than before.
Often, we as business managers are more reactive than proactive and sometimes we learn the hard way about contractor / employee rules "after it is too late." The time to review your contracts / contractor relationships is now, before you have a problem. Also, no matter what a contract states, the IRS will look at what actually occurs, not what is written in the contract. So, during this review, ensure that reality matches the words that are in your contracts.
Here are some of the considerations from the IRS when it comes to someone qualifying as an independent contractor:
-Does the company control or have the right to control what the worker does and how the worker does his or her job?
-Are the business aspects of the worker's job controlled by the payer? (How the worker is paid, whether expenses are reimbursed, who provides tools/supplies, etc.?)
-Are there written contracts or employee type benefits?
-Will the relationship continue and is the work performed a key aspect of your business?
Many more of these and more qualifications and aspects of independent contractors versus employees can be found here: http://www.irs.gov/businesses/small/article/0,,id=99921,00.html
This site also has many other links to assist you in navigating the contractor versus employee minefield.
As with so many other areas in our purview, it is well worth the time and expense to get your practice attorney and/or CPA involved if you have questions concerning a work relationship with a contractor. This is often a blurred matter and you will hear many different opinions on contractors, but time and resources will be best used prior to entering into a contractor relationship with anyone. The time spent will be much more affordable than the penalties and expense of choosing poorly at the onset of the contractor/employee start date. This decision making process is like many in our business - "You have to remove the penny from your eye to see the dollars."