By Jean Kruse / Guest Editorial

Need help with some aspects of your small business, but aren’t ready to add an additional employee? Many small business owners, when confronted with this situation, believe the only way they can afford to hire a person is to classify the new hire as an independent contractor so they do not have to pay the payroll taxes associated with an employee.

The Internal Revenue Service (IRS) has guidelines about when a person can legally be classified as an independent contractor and when the person is actually an employee. When a person claimed as an independent contractor is reclassified as an employee in an IRS audit, it can result in the imposition of back withholding and payroll taxes, fines and penalties, for which the employer becomes liable.

Another problem occurs when the person who has been classified as an independent contractor goes to Iowa Workforce Development and applies for unemployment compensation.  The agency will ask where they have worked for the past two years. When your business is listed as an employer, the agency will investigate to see why you did not report the person as an employee and pay the unemployment taxes on the wages.

To avoid these potential problems, it is important that businesses classify all persons accurately. The most important criteria to determine the difference between an employee and an independent contractor is whether sufficient “direction and control” is present to establish an employer-employee relationship. The following is a list of a few of the factors that you can use to measure direction and control:

  • An employee must comply with instructions about when, where and how to work
  • An employee is trained to perform services in a particular manner
  • An employee has set hours of work established by an employer
  • An employee works on the premises of an employer or at a location designated by the employer
  • An employee is paid by the hour, week or month
  • An employee is furnished significant tools, materials and other equipment by an employer
  • An independent contractor is paid by the job or on a straight commission
  • An independent contractor can make a profit or suffer a loss
  • An independent contractor provides services to two or more unrelated persons or firms at the same time

Independent contractors use their own resources to do the job, whether it’s tools, technology or people. The independent contractor is also responsible for incremental expenses required, including transportation charges, routine purchases, and time and materials above and beyond his/her estimate.

Still, the difference between an independent contractor and employee can easily be blurred to the point where they may well be considered your employee under federal and state law. So before you agree to an independent contractor relationship with anyone, make sure you understand what that means and carefully weigh the pros and cons. If you misclassify a worker, you could be liable for back employment taxes plus penalties.

These steps can help prevent an independent contractor from being misclassified as an employee:

  • Specify the task and contractor’s responsibilities/expectations in the contract
  • Avoid setting a pattern of daily or weekly work hours dictated by your business
  • Plan to compensate contractors on a per-job basis, not hourly, weekly or monthly
  • Do not include independent contractors under any insurance or benefits coverage you have for employees
  • Require the independent contractor, especially in the construction industry, to show proof that he/she has liability insurance coverage – you may need to show this proof to your insurance agent
  • Always require an invoice from the contractor before making payment

If you’re still uncertain as to whether your worker is a contractor or employee, IRS Form SS-8, “Determination of Worker Status for Purposes of Federal Employment Taxes and Income Tax Withholding” can be filed with the IRS by either you or the worker.

The IRS will review the facts and circumstances and determine the worker’s status. If you read the four-page form and apply the answers to your situation, you can probably make the determination yourself.

If you occasionally need extra help in your small business, consider hiring a person from a temp agency or outsourcing some of your work, such as bookkeeping, website management or marketing.

Getting sound advice on management issues such as independent contractor status is vital for your small business. For help, contact SCORE at (319) 362-6943 or ask for assistance at



Jean Kruse is a SCORE counselor and SCORE Iowa district president. She operated her own CPA firm for 13 years and in 1988, joined RSM McGladrey, a national firm, where she provided accounting and tax services to small businesses.