When deciding how to pay contractors for a job, you can pay by the hour. But paying by the hour can be a legally complicated choice.
The IRS looks closely at how workers are classified. They want to know whether a contractor is being treated like an employee. If the IRS judges that a contractor should have been paid as an employee, the consequences can be large financial penalties, opening the company up to civil liability, and even jail time.
The IRS has an 11 point main test for deciding who are contractors and who are employees.
- Instructions the business gives to the worker - contractors are less tightly supervised.
- Training the business gives to the worker - contractors generally already have the necessary training. Employees will sometimes be sent for trainings and seminars by their bosses, while contractors generally pay their own way to keep up on the latest practices in their industry.
- How many unreimbursed business expenses the worker has - the more expenses that go without being reimbursed, the more the scale tilts towards contractor.
- How invested the worker is - employees only invest their time, but contractors might bring their own equipment or tools to perform a job.
- How much the worker seeks out other jobs - contractors advertise for work, and often own their own business.
- How the business pays the worker - hourly versus salaried versus a specific sum for a job completed. Though being paid by the hour does not make a contractor an employee.
- How much of a profit or loss the worker can make - employees don't make money beyond their wages, unlike contractors who plan to make a profit off their work.
- What is written in the contract.
- What kind of benefits the business provides - contractors don't get paid days off or sick leave.
- How permanent or not the relationship between the worker and the business is.
- How important the services provided by the worker are to the business.
Generally, if most of the above conditions are met, contractors can be paid by the hour and not be employees. (Always consult a professional if you have any questions - this is your money and your time spent out of jail at risk.)
You can calculate an hourly wage by taking the total expenses for the job or what the cost for the full job would be and dividing by the number of hours worked. If you're thinking this would be a complicated calculation for the remodel of your bathroom, that's because those kind of contracting jobs aren't usually paid by the hour.
Lawyers are almost always paid by the hour. Computer programmers and consultants are generally paid by the hour as well. Doctors, psychiatrists, and CPAs also are more frequently paid by the hour.
When determining which method to use to pay contractors you have to choose between by the hour or by job. For most tasks, this is an easy choice. When it's not immediately obvious, you can use the test above to determine how the person doing the task would be classified.