It is so important to understand and correctly apply the rules for classifying a worker as an employee or as an independent contractor. The relationship between the worker and the employer determines if an employer must withhold income taxes and pay Social Security, Medicare taxes and unemployment tax on wages paid to an employee. If a person is an independent contractor, the employer normally does not have to withhold or pay any taxes on payments made to them. The earnings of a person working as an independent contractor are subject to self-employment tax.
Each situation is different and small businesses need to consider all evidence of the degree of control and independence in the relationship between them and the worker. The general rule is that an individual is an independent contractor if the payer has the right to control or direct only the result of the work, not what will be done and how it will be done.
Help with Deciding
There are three categories we like to use to determine how to properly classify a worker– Behavioral Control, Financial Control and Relationship of the Parties.
Behavioral Control: This is a very important category. If the employer directs and controls the work performed by the worker, even if that right is not exercised, then they are most likely an employee and not a contractor. Behavioral control categories are:
- Type of Instruction: The employer determines when and where to work, what tools to use or where to purchase supplies and services. Receiving the types of instructions in these examples may indicate a worker is an employee.
- Degree of instruction: If the business owner gives more detailed instruction, it may indicate that the worker is an employee. Less detailed instructions reflects less control, indicating that the worker is more likely an independent contractor.
- Evaluation systems: If the employer determines how the work is done then they are probably an employee. If the employer is only concerned with the end result, they may be an independent contractor.
- Training: Using periodic or on-going training about polices, procedures, and methods is a strong indication that the worker is an employee.Independent contractors ordinarily use their own methods.
Financial Control: How much control does the business have over the financial and business aspects of the worker’s job? Consider:
- Is there a significant investment in the equipment the worker uses in working for someone else?
- Are there expenses that are not reimbursed? (Independent contractors are more likely to incur expenses that will not be reimbursed than employees.)
- Is there opportunity for profit or loss? If yes, this is often an indicator of an independent contractor.
- The worker offers services available to the market. Independent contractors are generally free to seek out business opportunities.
- How is the worker paid? Typically, an employee is guaranteed a regular wage amount whereas independent contractors are most often paid for the job by a flat fee.
Relationship of Parties: How does the worker and business perceive their interaction with one another?
- Is there a written contract that describes the relationship the parties intend to create? Keep in mind that a contract stating the worker is an employee or an independent contractor is not a sufficient way to determine the worker’s status.
- Does the worker receive benefits? If a business provides employee-type benefits, such as insurance, a pension plan, vacation pay or sick pay have employees. Businesses generally do not grant these benefits to independent contractors.
- Is the relationship something that will be indefinite? (employee) Or is there a certain time frame? (independent contractor)
- Are the services provided by the worker a key activity of the business? If yes, they are probably an employee.
Consequences of Misclassifying an Employee
We understand that this can be confusing and are here to help make this as smooth as possible! If you classify an employee as an independent contractor with no reasonable basis for doing so you may be liable for employment taxes. If an employer can provide a reasonable basis for not treating a worker as an employee, they may have the opportunity to avoid paying employment taxes. See Publication 1976, Section 530, Employment Tax Relief Requirements for more information.
Certain eligible businesses have the option to reclassify their workers as employees with partial relief from federal employment taxes because of the Voluntary Classification Settlement Program (VCSP).
Employers can use Form SS-8 (Determination of Worker Status for Purposes of Federal Employment Taxes and Income Tax withholding) to determine the status of their workers. IRS Publication 15-A, Employer’s Supplemental Tax Guide, is also an excellent resource.
Please check our facts at IRS.gov