
Employee or Contractor? - chaostheory
http://www.inc.com/magazine/20080901/employee-or-contractor.html
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grellas
A murky area even by normal standards of law. The article goes through the
conventional analysis of what constitutes a contractor versus an employee.

Here are some practical points (of more particular interest to startups) that
go beyond the formal analysis:

1\. IRS uses a list of "factors" that, in practice, is so nebulous that most
large businesses do not fool with taking chances unless they can bring their
contractors within a "safe harbor" area.

2\. A 1986 tax act provided that tech service providers would no longer get
safe-harbor treatment and this immediately caused large tech companies to
retain contractors strictly (or at least largely) through a cottage industry
of agencies that cropped up in response to the change. From that point on, if
you wanted to hire yourself to a large tech company as a consultant, you had
to go through an agency or else be incorporated so they could hire your entity
instead of you personally. Microsoft paid dearly some years back when it had a
whole slew of contractors reclassified as employees after years of treating
them as contractors.

3\. The basic idea of the IRS "factors" is to determine if a contractor is
really in an independent business or if the classification is merely a veneer
for employee-like activity. One of the worst killers on this issue is if you
have longish-term contractors performing routine duties that are a regular and
recurring part of your core activities as a company - that activity spells
"employee" to the IRS.

4\. Early-stage startups usually have fewer issues in this area than do
established companies, not because they handle this issue correctly, but
because they are less likely to get snagged in an audit. Even small companies
_can_ get snagged, though, e.g., when one of its contractors gets terminated
and goes to file for unemployment. Generally, however, small companies do not
issue enough 1099's in any given year to raise that particular audit flag and
so tend to fly under the radar on this issue.

5\. A trap in this area is not to document the relationship. If you don't have
a written agreement specifying that the individuals are independent
contractors, you lose on the issue. If you do have a written contract so
specifying, you gain nothing except that you don't lose automatically based on
the absence of a proper written agreement alone.

6\. Even without the safe harbor, it is usually safe to hire independent
contractors who truly are in the business of providing services to multiple
customers. There is no special risk here and startups routinely use the
services of such contractors without incurring any special risks.

7\. After a VC funding, you will normally want to go with straight employees
for your startup, with exceptions of the type noted in #6 above. In addition
to avoiding the reclassification risks associated with contractors, hiring
people as employees is more conducive to protecting the company's IP and also
enables the company to use better incentives in the form of incentive stock
options (ISOs), which are available only to employees.

8\. If you are using a lot of "contractors" in your early-stage startup, be
absolutely sure that your startup is a limited-liability entity. If
contractors get reclassified, the liability generally attaches to the entity
only and not to its management. Penalties can be large because, if you cannot
track the contractors down and get them to certify that they actually paid
their taxes on their 1099 income, the company is required to pay (in addition
to normal payroll taxes) an amount based on the estimated _income_ tax that
such contractors should have paid on that income. For this reason, if you get
an audit covering a few years and have more than a handful of contractors
reclassified, the total tax/penalty hit can easily run into six figures.

9\. Based on all of the above, don't take needless risks in this area. Get
good professional advice and try to do it by the book.

~~~
chris11
I guess number two explains why I have heard of some companies keeping
contractors around for a maximum of one year.

My brother worked for Apple doing tech support as a contractor for awhile and
he said that once you had worked for a year you were either fired by the
employment agency or hired as an employee of Apple.

Also, I'm working as a contractor this summer for a power company, and I've
heard that it is policy that contractors can only stay for a year. One of my
coworkers started as a contractor worked for a little over a year, and ended
up getting fired for a few months until a full time position could open up and
he could be hired as an employee.

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russell
A friend once told me that when he became a contractor, he gave up the
illusion of security for the illusion of freedom.

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asimjalis
The legal issues aside -- from a hacker point of view what are the pros and
cons of working as an employee versus a contractor? One benefit of being a
contractor, especially with short-term contracts, seems to be that the hacker
gets exposure to many different technologies and corporate cultures.
Serendipity seems more likely. In the course of the contracts he might see a
problem/opportunity that could lead to a profitable venture.

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TJensen
This is interesting. I am currently contracting for a company in California,
though, if I read this and grellas' comment correctly, I really am an
employee. I wonder if this makes my position less secure or more.

