What are the differences between independent contractors and employees?
Improperly classifying workers as independent contractors when they are actually employees can create a myriad of problems with various federal and state agencies. Employment taxes due to both the IRS and the state governments are a primary concern, but there may also be insurance or labor law ramifications.
Benefits of hiring independent contractors
Why might a company prefer to have independent contractors?
It’s easier and cheaper. When a company pays an independent contractor, no taxes are calculated or withheld and the total payments made for an entire calendar year are reported on Form 1099. The company does not owe any employer tax on the payments made because the independent contractor pays the self-employment taxes himself. Payments to employees, however, must be reported on quarterly payroll tax returns and W-2s. Employee taxes are withheld and remitted frequently, and the company must also pay its employer share of taxes on the wages paid. Also, there are no requirements to offer health insurance or paid time off to independent contractors. However, the preference of a company or a worker to be classified in one way or another has no bearing on the facts and circumstances of the relationship. Merely agreeing to be called an independent contractor does not mean that the classification would be sustained if the relationship were examined by taxing authorities.
How to determine whether a worker is an employee or an independent contractor
In order to determine whether a worker providing services to a company is an employee or an independent contractor, the degree of control the company has over the worker must be considered. There are three categories of control to examine: behavioral, financial, and type of relationship.
Behavioral control would be demonstrated if the company has the right to control what the worker does and how he does his job. Does the company specify when and where work is to be done and in what order the tasks are to be completed? Does the company provide specialized training for the worker or require him to attend meetings regarding the work? Must the work be done at the company’s office during specified business hours? If the answers to these types of questions are yes, then the relationship is likely one of an employer and employee.
Financial control is indicated by the method and timing of the business aspects of the worker’s job. Does the company reimburse the worker for expenses? Is the worker paid in regular intervals, such as hourly, weekly, or monthly? Does the company provide supplies and tools for the job? If so, these factors would tend to indicate an employer and employee relationship. Conversely, if a worker can hire his own assistant, if he has the possibility of realizing either a profit or loss as a result of his services, or if he makes his services available to the general public, then he might be an independent contractor.
The type of relationship category looks at factors like whether or not there are written contracts or employee type benefits. Is the work performed by the worker a key component of the company’s business? If so, then the worker might be an employee.
A company must weigh all factors when determining how to classify a worker. There is no set number of factors that definitively determines whether a worker is an employee or an independent contractor. The key is to look at the entire relationship. If you are still uncertain, a Form SS-8 can be filed with the IRS to ask for a determination. This review can take several months, but it might be worthwhile if you continually hire the same types of workers to perform particular services and the classification is unclear. For employers who have been improperly treating workers as independent contractors, there is an IRS “Voluntary Classification Settlement Program” that provides partial relief from federal employment taxes for eligible taxpayers that agree to prospectively treat workers as employees.
A company can eliminate future financial and legal complications by properly classifying workers when the relationship begins. The desire to simplify reporting and avoid paying payroll taxes does not change the actual substance of a company’s relationship with its worker.
If you’d like help with ensuring you’re correctly classifying your workers, Email us or call (856) 667-6225
About the Author: Julie Strohlein, CPA
Julie is a CPA and senior member of the Alloy Silverstein team. She has over 20 years of accounting and tax experience with diverse clientele and frequently presents in-house training to keep our staff up to date with technological advances. If you’d like to know more about how Abacus Payroll Inc. or the Alloy Silverstein Group can help your business, please call us at 856-667-6225 or Email us.