Employee or Independent Contractor? Know the Rules
The IRS encourages all businesses and business owners to know the rules when it comes to classifying a worker as an employee or an independent contractor.
An employer must withhold income taxes and pay Social Security, Medicare taxes and unemployment tax on wages paid to an employee. Employers normally do not have to withhold or pay any taxes on payments to independent contractors. Employees are typically more expensive to companies because employers have to pay payroll taxes and provide other benefits to their employees, but not to independent contractors, noted Jenny Kim, a WNDE tax manager. Therefore, “you’ll see many employers attempting to classify their employees as independent contractors, especially small businesses.”
Often, the workers themselves don’t know the difference, she continued. One of her clients, for example, had its employees sign an agreement stating that they were independent contractors. However, one employee was involved in a car accident while working and identified himself as an employee of the company. The client was ultimately contacted by the California EDD, and had to prove that the worker was an independent contractor rather than an employee.
Another client had an employee file for unemployment benefits under similar circumstances causing the same problem for his client. In both cases, the workers themselves were unaware of their employment status and therefore misrepresented themselves, Jenny said.
She continued, “This lack of knowledge on the part of the employee causes problems for their companies. It is important for business owners to know the difference between employees and independent contractors and treat them accordingly.”
Workers must also understand their status, she said, especially if they are working as independent contractors.
Here are two key points for small business owners to keep in mind when it comes to classifying workers:
1. Control. The relationship between a worker and a business is important. If the business controls what work is accomplished and directs how it is done, it exerts behavioral control. If the business directs or controls financial and certain relevant aspects of a worker’s job, it exercises financial control. This includes:
• The extent of the worker’s investment in the facilities or tools used in performing services
• The extent to which the worker makes his or her services available to the relevant market
• How the business pays the worker, and
• The extent to which the worker can realize a profit or incur a loss
2. Relationship. How the employer and worker perceive their relationship is also important for determining worker status. Key topics to think about include:
• Written contracts describing the relationship the parties intended to create
• Whether the business provides the worker with employee-type benefits, such as insurance, a pension plan, vacation or sick pay
• The permanency of the relationship, and
• The extent to which services performed by the worker are a key aspect of the regular business of the company
• The extent to which the worker has unreimbursed business expenses
When the IRS or state agencies investigate the cases, Jenny said, they will consider a combination of facts to determine if an employee is an employee or independent contractor. At the start of employment, for example, an independent contractor signs an agreement saying he is working as an independent contractor. However, if the worker must arrive at work at certain time, has been given specific directions regarding a job, is paid on a regular basis and is reimbursed for job-related costs, the worker should be viewed as an employee.
The IRS can help employers determine the status of their workers by using form Form SS-8, Determination of Worker Status for Purposes of Federal Employment Taxes and Income Tax Withholding. IRS Publication 15-A, Employer’s Supplemental Tax Guide, is also an excellent resource.
For additional information, please contact your WNDE representative.