Employee versus Independent Contractor
It is critical that business owners correctly determine whether the individuals providing business services are employees orindependent contractors. As a general rule, you must withhold income taxes, withhold and pay Social Security and Medicare taxes, and pay unemployment tax on wages paid to an employee. Generally, you do not have to withhold or pay any taxes on payments to independent contractors.
On the surface it would then appear that as a business owner, you would prefer to have a person classified as a contractor. One of the pitfalls to treating a possible employee as a contractor is if the "contractor" is injured. If a sympathetic judge agrees he/she should have been treated as an employee, the business will not be covered by Worker's Compensation Insurance and the damages are to be fully paid by the business.
You should also note that Colorado has increased their audit efforts in this area in an attempt to gather state unemployment taxes, which are not paid if the business treats a person as a contractor.
Changes in various state and federal laws are likely going to have an effect on the analysis given to independent contractors. The Affordable Care Act will require many employers to cover employee health insurance and thus there will likely be incentives for employers to classify workers as independent contractors. As a result of these classifications, there has been an increase in IRS audits regarding worker status.
If you determine that your business wishes to pay a person as an independent contractor, then you must meet a 21 topic factual test which has been issued by the courts and followed by the IRS.
The most important consideration with any independent contractor (also an issue considered important in audits) is whether there is an independent contractor agreement in place. Factors indicating employment status rather than contractor status include: whether the business provides work space or tools to the person; whether business employees direct and supervise the person; whether the person has no other businesses that he/she provides services and whether expenses of the person are reimbursed by the business. Though there are several other items to consider, these items are the foundation for the determination of independent contractor classification. If you determine that you wish to enter into an independent contractor relationship with a person, we strongly suggest you consult a lawyer to draft this agreement.