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Independent Contractor Status -
How to Demonstrate that you are Self Employed





Independent Contractor Status - Introduction
As time passes it is becoming increasingly difficult to distinguish between different ways of working. If you are working as an independent contractor it is of vital importance that you understand the criteria that the government, and in particular the tax authorities use to distinguish employees from those with genuine independent contractor status.

If you get this judgment wrong there can be significant financial penalties because you will have been paying tax as a self employed person, most likely at a lower average rate than an employee.

If your local tax authority (IRS in the US; HMRC in the UK) ultimately determine that you should have been paying tax as an employee, then not only will you have to pay the difference in tax but you will probably be liable for interest on tax that has been underpaid and possibly some penalties too.

How to demonstrate your independent contractor status
The onus is on self employed individuals to understand the criteria used to determine self employed status and to form a judgment as to whether the way he or she is operating is in line with those criteria.

There are a number of resources available on this site (summarised below) to guide you in making that judgment, but ultimately, you should seek independent professional advice from your accountant or tax planner to confirm that you have correctly interpreted the rules.

Operating model
First take a look at the different operating models, working through the continuum from employee through contractor and consultant. Establish where you are operating on the continuum and take some time to think through the tax status of each of the entities in the contracting or consulting relationships that you have.

Contractor Tests
The main tests of independent contractor status are set out here. There are twenty tests in total and you should regard them as a framework within which to judge where your own operations actually sit.

It is important to realize that it is not necessary to satisfy every one of the test criteria but that, on balance, the majority of criteria should be satisfied.

In forming a judgment, the tax authorities will assess the way you're working and form a balanced opinion based on the number of criteria you are able to satisfy and the strength of the evidence put forward in support of each test point.

IR35 considerations
In the UK, HM Revenue & Customs are alive to the possibility that the substance of the relationship between some contractors and buyers of their services is in essence that of employee and employer, rather than being an arm's length business-to-business relationship.

In these cases, HMR&C can challenge the contractor under the IR35 legislation and if successful reclaim any underpaid tax with interest and penalties. The tests used for IR35 are broadly similar to the US IRS tests set out on the contractors test page.

1099 independent contractor relationships
For the same reasons as it is important for a contractor to be able to evidence his independent status insofar as it relates to his business relationship with his clients, it is equally important for the main (lead) contractor to be able to evidence the independent status of his subcontractors.

In other words, the lead contractor needs to be able to evidence that his subcontractors genuinely do have independent status rather than operating as his own employees. Follow the link for more information on the 1099 independent contractor agreement. and be sure to take independent professional advice.

Conclusion
The investment of some time and effort in reviewing the way you are operating will significantly reduce the likelihood that your independent contractor status will be challenged.

Furthermore, if it is challenged, then familiarity with the main criteria will significantly improve the probability that you will be able to successfully defend your position.


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