4 Questions Companies Need To Ask About Freelancers Before The IRS Comes Calling

Misclassification of workers as freelancers and independent contractors instead of full-time employees has resulted in billions of dollars in lost tax revenues.

Companies don't have to pay worker's compensation, unemployment, and disability taxes for freelance and contract employees (s0-called '1099 workers'). The problem is, if you're getting treated like other full-time salaried employees and you have the same assignments and tasks they do, you should be receiving those benefits.

Your employer should be paying those taxes.

“I think this is a massive problem that will be more evident in the coming years,"Jeff Ward, co-founder of Work Market, tells Business Insider. Ward's company works with firms like Lockheed Martin and Omnicom to prevent misclassification of employees, which could trigger an audit by the IRS.

Remember when Microsoft had to pay the IRS $97 million on a benefits case brought on by long-term temps who should have been classified as W-2 (full-time, salaried) workers? This is exactly the situation that Work Market is trying to prevent.

"You can 1099 anyone you want, but are they really an independent contractor? In the end, it's a judgment call by the government," he said.

How do you know the difference between a 1099 and a W-2 worker? Ward says there are a few questions you should ask yourself:

1. Who does this person really work for?

To figure out if an employee is really a freelancer or independent contractor, ask yourself: does she provide services for several companies at a time? Does she have an actual business? Does she have an office she works out of? Does she have marketing materials for her business? Or a business bank account?

If you answer "no" to these questions, she is likely a W-2 employee.

2. How do you pay this person?

Freelancers and contractors should be paid a fixed fee for assigned projects, says Ward. Unlike full-time salaried employees, a freelancer's financial situation should not be solely reliant on your business.

Avoid paying this person an hourly, daily, or weekly rate, reimbursals for expenses, or bonuses. You should also refrain from providing tools, such as computers, because if they are working on multiple projects at a time, freelancers should be able to provide their own equipment.

Basically, the more financial independence they have from your business, the less risk there is in misclassifying them.

3. How do you interact with this person?

You need to ask yourself how you're treating your freelancers. Do they have to be somewhere at a certain time? Do you check up on them often? If the answer to these questions is "yes,"they are likely a W-2 worker.

"An employee is told what to do and how to do it, and an independent contractor is told what needs to be done," Ward says.

4. Is this person doing the same job as other full-time employees?

Ward says if you're hiring freelancers so you don't have to hire more full-time employees, you're putting your business at risk of an audit.

"If he's an individual who comes into your office, is told what to do, sits in front of a computer next to a bunch of other workers, and does the same job they do, that's a problem," he says.

The IRS will want you to explain why one person is an employee and the other is not. If your answer is that you only needed the 1099 worker for six months, it won't be acceptable to the IRS.

"There's a massive movement in how things are going to get done," Ward says. "It's going to be a mess for awhile as all these things shift and change."