And do you know the difference? The IRS does, and they’re checking your records.
Employee – Generally, you must withhold income taxes, withhold and pay Social Security and Medicare taxes, and pay unemployment tax on wages.
Independent contractor – You do not generally have to withhold or pay any taxes on payments.
These statements make hiring independent contractors sound like the way to go for small business, don’t they? So, what’s the catch if you do?
If you classify an employee as an independent contractor and the IRS deems they are actually an employee, you will be held liable for employment taxes for that worker as well as fees and penalties.
To determine how to pay a worker, you must first know the business relationship between you and the person performing the services.
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 and not what will be done, how it will be done, or where it will be done.
(Earnings of a person working as an independent contractor are subject to Self-Employment Tax.)
Anyone who performs services for you is your employee if you can control what will be done and how it will be done. This is so even when you give the employee freedom of action. What matters is that you have the right to control the details of how the services are performed.
The IRS considers the existence of an employer-employee relationship to depend on whether the worker is subject to the “will and control” of the employer, based on the following factors:
- Instructions. Employees (i.e. not contractors) typically must follow instructions as to when, where, and how to perform the job.
- Training. Requiring training supports employee status.
- Integration. Integration of the worker’s services into the business operations suggests that the hirer directs and controls the worker.
- Services rendered personally. If services must be rendered personally by a specific worker, the hirer controls the methods used to complete the work.
- Control of assistants. Control by the hirer over the hiring, supervision, and pay of assistants implies employee status.
- Ongoing relationship. A continuing relationship suggests that an employer-employee relationship exists.
- Set hours of work. The establishment of set hours by the hirer implies control over the worker.
- Full time work. A worker who must devote full working time to the hirer is being controlled.
- Work on hirer’s premises. On-premises work indicates employer control, especially when the work could be done elsewhere.
- Order or sequence. Work that must be performed in an order or sequence established by the hirer suggests control.
- Reports to hirer. A requirement that the worker submit regular oral or written reports to the hirer implies control.
- Payment method. Payment by the hour, week, or month generally indicates an employer-employee relationship. Payment by the job or commission indicates independent contractor status.
- Payment of expenses. Payment of the worker’s business or travel expenses suggests an employer-employee relationship; the hirer is regulating and directing the worker’s activities.
- Significant investment. Independent contractor status is implied if the worker invests in the facilities used for the work. Absence of investment indicates an employer-employee relationship.
- Realization of profit or loss. A worker who can realize a profit or suffer a loss as a result of providing services is usually an independent contractor.
- Serving more than one firm. A worker who provides services to several unrelated firms at the same time generally is an independent contractor.
- Serving the public: A worker whose services are regularly available to the general public is an independent contractor.
- Right to discharge. The right of the hirer to discharge the worker at any time is a factor indicating an employer-employee relationship.
- Right to quit. A worker with the right to terminate the relationship with the hirer at any time without liability is generally an employee.
The presence or absence of any one of these factors is not determinative or conclusive; rather the IRS will consider all of the factors affecting the relationship.
Facts that provide evidence of the degree of control and independence fall into three categories:
Behavioral: Does the company control or have the right to control what the worker does and how the worker does his or her job?
Financial: Are the business aspects of the worker’s job controlled by the payer? (these include things like how worker is paid, whether expenses are reimbursed, who provides tools/supplies, etc.)
Type of Relationship: Are there written contracts or employee type benefits (i.e. pension plan, insurance, vacation pay, etc.)? Will the relationship continue and is the work performed a key aspect of the business?
We, personally, tried hiring independent contractors as administrative help. It became quite difficult to manage within the guidelines. Our tendency was to give the contractors too much direction and the IRS saw that as an employee relationship. Even when using rehab contractors, we ran into difficulties with liability when purchasing and supplying materials for the contractor to use. This, again, creates an employee type relationship and can be used against you if there is a lawsuit. Bottom line, if you act like an employer, you’re an employer.
After reviewing the three categories of evidence, if it is still unclear whether a worker is an employee or an independent contractor, Form SS-8, Determination of Worker Status for Purposes of Federal Employment Taxes and Income Tax Withholding (PDF) can be filed with the IRS by either the business or the worker. The IRS will review the facts and circumstances and officially determine the worker’s status.