An independent contractor is a person, business, or corporation that provides goods and services to another organization or entity. These goods and services are provided under specific terms as a verbal agreement or formal written contract.
The Internal Revenue Service (IRS) generally identifies contract work as a client relationship where the payer controls or directs the result of the work. The payer doesn’t control how the work is performed. Any earnings received by the independent contractor is subject to the self-employment tax. Since independent contractors are not classified as employees, their earnings are not subject to FICA or Income Tax withholding.
One of the major characteristics of independent contract work is that the individual doesn’t perform regular work for the employer. The independent contractor has a relationship with the employer when they are required for a project or specific period of time. Many independent contractors work under a franchise or a larger umbrella company. These companies often assist them in retaining assignments or negotiating pay.
Contractors have control over the number of hours they work and the type of job accepted. They invest in their own supplies, equipment and technology. They also must have their own insurance – whether in the form of health insurance or business related liability insurance.
IRS requires that any company or organization that pays in excess of $600 to an independent contractor must report it to the IRS. They must provide the contractor with a Form 1099-MISC showing earnings in the year.
The IRS has strict rules over what classifies an individual as an independent contractor. The IRS performs employment audits if it suspects that an employer is abusing this relationship. The most important determining factors of contractor and employer relationships include:
financial control: How much financial control does the company have over the contractor?
behavioral control: Does the contractor perform supervised work or direct how the work is performed?
permanence: How long has the company employed the contractor? Is the contractor working on projects that eventually end after a period of time?
Companies or entities who violate these basic contractor rules, may do so to avoid paying Federal Income and FICA taxes on behalf of their employees. These companies are forced to convert their contractor workforce into employees and may face heavy penalties/fines from the IRS.