Recently we have had several clients that have been audited with the focus being the validity of independent contractors. Many businesses pay a vendor as an independent contractor. Here is a quick guide for you to determine if a vendor is an independent contractor and how to document each contractor to ensure you have the proper proof.
Independent contractor rules:
If the following four conditions are met, you must generally report a payment as nonemployee compensation.
You made the payment to someone who is not your employee;
You made the payment for services in the course of your trade or business (including government agencies and nonprofit organizations);
You made the payment to an individual, partnership, estate, or, in some cases, a corporation; and
You made payments to the payee of at least $600 during the year.
The Proper documentation for an independent contractor:
1. A W-9 form filled out by the contractor. You can find a blank W-9 form on the IRS website.
2. A copy of the contractor's business license.
3. A copy of the contractor's general liability and workers compensation insurance policies. While many independent contractors will argue that they do not need workers comp insurance because they don't have any employees they are incorrect. If they do not have any employees they are still required to have a workers comp exemption certificate.
4. Proof that the contractor is pursuing other clients or business. Now here is where I disagree with the auditors. I am not quite sure why this burden should fall on the business owner. Now the state and federal government want us to take the time to make sure that the contractor is pursuing other business? We have to make sure they are good business people and have an advertising plan? Really the whole thing is just getting to ridiculous for me. A copy of a business card would be more than sufficient evidence that your contractor has the intentions of pursing additional business and clients outside of your business.
If you take the time to make sure all the contractors you pay are set up as a business and not an individual it will only help you. If you follow the rules and document the contractor appropriately you should have no issues in an audit. Also, don't every pay an independent contractor until you have all the proper documentation. You will be surprised how cooperative people can be when they have not been paid and how uncooperative they can be when they have already been paid.