What are the Tax Implications of Hiring a Sub-contractor or Freelancer?

The big news in the business world, especially as the economy expands, is the conversion of a “jobs” economy to a “gig economy.” A gig was originally just a side job, but more fulltime self-employed individuals will tell you that they’re happy to be a fulltime participant in the gig economy. There are a great many benefits for them, but there also must be some benefits for the employer who decides to use more freelancers or sub-contractors and fewer fulltime employees.

What’s a Gig Worker?

A “gig” worker in today’s economy is hired for short-term work or specific projects and they work as an independent contractor. Some build relationships with clients that can last years, but they’re never an employee of the company. According to the IRS, an independent contractor is responsible for paying the full employment taxes, Social Security and Medicare, on the compensation they receive.

What Can I Save Using Independent Contractors?

The business that uses a freelancer realizes a tax savings in not having to pay the employer half of Social Security and Medicare taxes. You also can deduct the total invoiced costs of their work. According to the Bureau of Labor Statistics, employers can save up to 30% of the average employee’s total compensation package on:

  • Employment taxes
  • Health insurance costs
  • Retirement benefits
  • Unemployment tax savings
  • Larger companies can save on not having to comply with the Family Medical Leave Act and the Affordable Care Act
  • Legal risks to their business of employee actions

There isn’t a long list of tax savings in using freelancers or sub-contractors. However, the other benefits and cost savings are compelling and can result in the decision to avoid staffing up using independent contractors.

Where Can I Go Astray with the IRS Using Gig Workers?

There are savings in taxes using gig workers, and adding those other cost savings, it seems like a slam dunk decision. However, the IRS has some strict rules to follow in determining if someone you hire is an employee or an independent contractor. Failure to meet the IRS tests can result in reclassification of a sub-contractor to employee status, with some major tax consequences and penalties. The major test questions in determining their status include:

  • Do you set their workdays and/or hours? If you do in any way, they’re an employee. You can set deadlines for delivery of work though.
  • Do you provide a work area? This can cause them to be reclassified, though not necessarily if their work must be performed in your area or on your equipment, such as a sub-contracted computer technician.
  • Do you provide them with equipment to perform their work? You’ll most certainly have a problem if you’re providing computers, printers, etc. for normal work functions.
  • How do you pay them? Don’t pay them weekly, semi-monthly, etc. as you do your employees. Pay by the job or on delivery of work and through an invoice they submit.
  • Do you provide training or education for them? If so, they’ll probably be classified as employees.
  • Do you limit them to working only for you? This is a red flag to the IRS.

Some of the IRS tests are not either-or or slam dunk yes or no questions, as there can be situations that may go either way. The best approach is to consider your gig workers as independent companies, providing all their own expertise, equipment, and workspaces. They should be given specific jobs with delivery dates with little or no other involvement or scheduling on your part.

What Other Concerns are There in Using a Gig Worker?

Other than the normal quality of work concerns, have a contract that specifies that the work they deliver is “work for hire.” This means that you own the work after it’s delivered, and they give up their rights to it. Other than that, hiring gig workers is definitely less accounting and management hassle.

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