Employees Versus Independent Contractors

Q: "If I hire people to help me with my eBay business for a few hours each week, can I treat them as independent contractors for tax purposes?"

A: Unless they are your business partners (see previous questions), everyone who works with you in your eBay business is either an employee or an independent contractor for tax purposes.

If people are your employees, you must withhold income and payroll taxes from the money you pay them, and they are entitled to all of the many rights afforded to employees by federal and state law. Give them IRS Form W-2 each January, showing the income and payroll taxes you withheld and the gross amount of their wages for the preceding calendar year.

If people are your independent contractors, you don't withhold income and payroll taxes from the money you pay them and they have none of the legal rights that employees have. If you pay them more than $600 total during the calendar year, send them IRS Form 1099 each January, showing the gross amount of their compensation for the preceding calendar year.

When people work for you part-time or only occasionally (such as during your holiday season "crunch time"), you would like to treat them as independent contractors so you don't have to deal with all the legal and tax paperwork. The trouble is, you often can't.

The law here is simple to state, but difficult to apply in practice: If you can "direct and control" people's activities while they are working with you, by telling them what to do, when to do it, where to do it, and how to do it, they are your employees, even if they work only a few hours each week (or just during the holidays). If you cannot "direct and control" people's activities—they get to determine their own hours and decide how, when, and where the work will be done—they are independent contractors.

It sounds simple, doesn't it? But the devil lives in the details. Here are some examples to show how tough this decision can be:

• You hire a student intern to help put up your eBay listings; he comes over to your home on Wednesday afternoons after class and works for three hours before going home for dinner. The student intern is a part-time employee and should not be treated as an independent contractor because he works a regular schedule and you provide him with all the tools and equipment necessary to do his job.

• You hire a neighbor to help you pack boxes and ship the items you sell on eBay "for ten hours a week." Each week she works different days, depending on her child's day-care schedule, but she has to work ten hours a week, and when she is working on your premises you assign her projects and otherwise control her working hours. This person is a part-time employee and should not be treated as an independent contractor, even though there's no regular schedule, because you require a certain number of hours each week and (most important) control her time whenever she is available to work for you.

• You meet someone at a local networking group meeting who is temporarily out of work. You ask him to help you put listings on eBay for a few hours a week to give him some money until he finds other work. After a while, however, he's working sixty hours a week for you, you are his sole source of income, and he isn't looking for work elsewhere because he is comfortable with the money you are paying him. This person is an employee for tax purposes, since he doesn't work for anyone else and doesn't have a reasonable chance of working for someone else because of all the hours he's working for you.

• You hire an attorney to review a purchase contract. You tell him you need his comments by Friday of this week because that's when you are meeting with the vendor to review the contract, but in between now and Friday the attorney is free to schedule this job whenever he wants and he is not limited in the amount of time he can spend reviewing your contract (other than his personal ethics and his desire to keep you as a valued client). The attorney is an independent contractor for tax purposes.

• Your bathroom toilet has sprung a leak. You call a plumber, who comes to your house, bringing all his tools and equipment with him, and spends four hours repairing your toilet, even though he estimated it would be only a two-hour job. The plumber is an independent contractor for tax purposes because he is in control of his time, works for lots of other people, and uses his own tools and equipment.

See how tricky this gets? It isn't always easy to tell if someone is an employee or an independent contractor for tax purposes, and you have to get it right. The IRS audits this area of tax law very aggressively, and they focus their attention on small business owners. If you're not exactly sure if you are "controlling" someone's activities enough to make them an employee, talk to an attorney who specializes in labor and employment law and get his or her opinion. This is one area of the law where guesswork doesn't pay.

Q: "If someone works for me less than ten hours per week, is he an employee or an independent contractor for tax purposes?"

A: There is no minimum number of hours that makes someone an independent contractor or an employee for tax purposes. Even someone who works only a few hours a week can be an employee if you control his activities during the time he is actually working for you.

Q: "If I have a written agreement with someone in which he agrees that he is an independent contractor for tax purposes, will the IRS be bound by that?"

A: No. If your business is ever audited by the IRS, the auditor will look at all the facts and circumstances of the relationship to determine whether the individual is actually an employee. If they determine that he is, the IRS is free to disregard the written agreement and slap you with interest and penalties on all the payroll taxes you should have been paying on this individual's wages.

Q: "If someone working for me has her own corporation or limited liability company (LLC), can I sign a contract with her corporation or LLC rather than with her personally and treat her company as an independent contractor?"

A: Generally, only natural persons (human beings) can be employees for tax purposes—legal entities such as corporations and LLCs cannot. But if the individual is the sole owner or "member" of the corporation or LLC and hasn't been paying close attention to the legal and tax paperwork that has to be done when you have a legal entity, there's a good chance that the IRS will pierce the corporate veil on audit and disregard the person's corporation or LLC on the grounds that it existed solely to help her (and you) avoid taxes. If it's a "real" corporation or LLC, with other owners and lines of business that don't involve you, you may have a stronger chance of claiming independent contractor status for the company (not the individual).