Business Tip of the Day

Wednesday/December/21 08:00 Filed in: tip of the day
Last year we hired someone to act as a consultant to our business. We treated her as an independent contractor, but we only recently learned that we were this person's only client last year, and our attorney says there's a possibility this person might be considered an employee of ours. Should we send the consultant a W-2 or a 1099 at this point?
 

Your attorney is 100-percent correct. Your consultant has failed one of the basic tests of independent contractor status--that the consultant has other clients. Without knowing more about the relationship, though, no one can say for sure if she was or not. For example, if the consultant did all her work at her own location, worked less than 1,000 hours last year, and submitted regular invoices for her hourly fees and reimbursable expenses, she may still be considered an independent contractor even though you were her only client. You won't know for sure unless you go through an audit and the IRS agrees with your position.
 
If you send her a W-2, you are admitting that she was an employee last year, and you'll be liable for Social Security, Medicare, and federal and state unemployment taxes on the amounts you paid her (along with interest and penalties for paying these taxes late). Talk to your attorney some more about this relationship, and see if you have any good-faith defenses to a claim that the consultant was an employee. If the attorney feels that you do, you can send the consultant a 1099 for last year. Just make sure she pays all federal and state withholding taxes on the amounts you paid her last year (don't be afraid to ask for proof, such as a copy of her tax return for that year). Not a risk-free solution, but the best you can do under these circumstances
 
Then, keep an eye on the relationship going forward. If you continue to be her only client, and especially if she is working so many hours that realistically she doesn't have time for other clients, you should put her on the payroll and start paying employment taxes to avoid liability this year.

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