Many business owners want to avoid payroll taxes by classifying an individual as an independent contractor. While this is true in some cases, it is imperative that you know if you have a tax liability or not. This is determined by the worker’s employment status. As a business owner it is crucial that you can determine if the individual you have working for you is an employee or an independent contractor. So who cares and why should you? What is the difference anyway?
THE IRS CARES.
What is the difference?
According to IRS.gov here are the general definitions of independent contractor and employee:
Independent contractor – the payer has the right to control or direct only the result of the work and not what will be done and how it will be done. The earnings of a person who is working as an independent contractor are subject to Self-Employment Tax and you as the business owner, will not have to withhold or pay taxes on the payments you make to the independent contractor. In this case, the company will give you a W-9 and your company will issue a 1099 to the independent contractor.
Employee – anyone who performs services for you and you can control what will be done and how it will be done. On wages paid to an employee, you as the business owner must withhold income taxes, withhold and pay Social Security and Medicare taxes, and also pay unemployment taxes. In this case your employee is required to submit a W4 when they start, and at the end of the year they are issued a W-2 by your business.
Why Should You Care?
If you misclassify a worker as an independent contractor you can end up with large tax bills, along with facing penalties for not paying employment taxes or filing the required tax forms.
The IRS wants employers to look at all the facts and circumstances around the work of the individual. According to the IRS Website: “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.)
- Relationship Type: 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?
Businesses must weigh all three of these factors when determining whether a worker is an employee or independent contractor. Some factors may indicate that the worker is an employee, while other factors may indicate that the worker is an independent contractor. There is no “magic” or set number of factors that “makes” the worker an employee or an independent contractor, and no one factor stands alone in making this determination. Also, factors which are relevant in one situation may not be relevant in another.
The keys are to look at the entire relationship, consider the degree or extent of the right to direct and control, and finally, to document each of the factors used in coming up with the determination.
is no “magic” or set number of factors that “makes” the worker an employee or an independent contractor, and no one factor stands alone in making this determination. Also, factors which are relevant in one situation may not be relevant in another.
The keys are to look at the entire relationship, consider the degree or extent of the right to direct and control, and finally, to document each of the factors used in coming up with the determination.”
If after reviewing the three categories of evidence, it is still unclear whether a worker is an employee or independent contractor, your company can file Form SS-8, and the IRS will make a determination for you.
Real World Examples:
The IRS would probably classify an accountant as an independent contractor, IF the accountant works on an as needed basis. S/he decides what days they will work and invoices the company when s/he is finished. The accountant also does work for other companies and represents him or herself to the public as working for themselves.
Conversely, the IRS would probably classify the accountant as an employee, IF the accountant works specific hours set by the employer, uses the employer’s equipment, has an hourly rate, and claims that s/he works for the employer’s company.