As a successful freelancer, your client list will eventually grow to the point where you’ll have more work than you can handle.
When that happy day rolls around, you’ll need to make a decision: Do you refer extra work to a colleague (who may do the same for you someday) or do you hire another freelancer to help you out?
Just as you work on projects that companies can’t – or won’t - do in-house, you can outsource some tasks in your business to a freelancer. That may mean you bring on a virtual assistant or hire a home-based marketer. Or it may mean that you need help with your core business and assign out some projects to a professional who specializes in work that is similar or related to your own.
Until you get to the point where you are ready to hire full-time employees – a big leap for a self-employed individual – hiring independent contractors is usually your best bet. Along with skipping administrative hassles, payment of benefits and the time-consuming hiring process, you’ll save at least 10 percent on payroll taxes and workers' compensation if you use freelance workers to supplement your business output.
But you’ll have to be careful about separating out freelancers (the IRS calls them “independent contractors”) from employees, because our tax system treats the two very differently. And even if you didn’t intend to hire someone onto your payroll, if you treat a contractor as an employee, the IRS may catch on to that and second-guess you in the form of a federal labor audit or New York State labor audit.
The IRS uses a checklist, The Determination of Worker Status (form SS-8), that you can download here. The checklist helps you evaluate whether an individual is an “independent contractor” or an employee for tax purposes. Generally speaking, if you outsource work to an freelancer who has multiple clients and controls her own work schedule, that person will be considered an independent contractor. If you’re outsourcing to someone who works exclusively for you, under your specific training and direction and on a work schedule you establish, the IRS will probably consider that person your employee for tax purposes.
What’s the difference? Quite a lot. If you’re working with a freelancer, you don’t have to withhold payroll taxes or issue a W2 form to that person. You simply pay their invoices and issue them a 1099 tax form at the end of the year. If the IRS determines that, for all intents and purposes, you’ve got an employee, you’ll need to withhold payroll taxes and issue a W2 form. And if the IRS finds that you’ve been an employer for some time but haven’t been following the tax rules, you could be hit with interest on back taxes, and maybe even penalties.
The IRS looks at the relationship between the freelancer and the organization to help determine who works as an independent contractor. Just having a written contract that refers to an individual as a freelancer does not mean he is truly a freelancer. If you’re paying him for sick time or giving paid vacations, he’s going to be judged to be an employee. But even if you’re not paying benefits, you still may have an employee as defined by the IRS if: an individual is essential to operating your business and you exert control over that person’s work for an open-ended period of time.
This IRS article goes into the details of determining who is an independent contractor and who is an employee.
With many states and the federal government hurting for revenue, audits are increasing, even on self-employed persons and small businesses. If an audit determines that you've misclassified an employee as a contractor, you could be hit with back taxes and worse. CPA for Freelancers™ can guide you in ensuring that any freelancers to whom you are outsourcing work match the IRS guidelines. This is part of the service we provide as an accounting firm focused specifically on New York state freelancers and self-employed individuals.
Don’t risk it: Make sure you know the rules and are following them from the start as a responsible freelancer.
©2021 MEDOWS CPA, PLLC