Contractor or Employee? – Knowing the difference is important

Is a worker an independent contractor or an employee? This seemingly simple question is often the contentious subject of numerous IRS audits. As an employer, getting this wrong could cost you plenty in the way of Social Security, Medicare taxes, and other employment related taxes. Here is what you need to know.

The basics

As the worker. If you are the worker and you are not considered an employee you must;

  • pay self-employment taxes (Social Security and Medicare related taxes)
  • make estimated federal and state tax payments
  • handle your own benefits, insurance, and bookkeeping

As the employer. You must ensure your employee versus independent contractor determination is correct. Getting this wrong in the eyes of the IRS can lead to;

  • payment and penalties related to Social Security and Medicare taxes
  • payment of possible overtime including penalties for a contractor reclassified as an employee
  • legal obligation to pay for benefits

Determining the answer: things to consider

When the IRS recharacterizes an independent contractor as an employee they look at the business relationship between the employer and the worker. The IRS focuses on the degree of control exercised by the business over the work done and they will assess the worker’s independence. Here are some tips.

  • The more the employer has the right to control the work, when the work is done, how the work is done, and where the work is done, the more likely the worker is an employee.
  • The more the financial relationship is controlled by the employer the more likely the relationship will be seen as an employee and not an independent contractor. To clarify this, an independent contractor should have a contract, have multiple customers, invoice the company for work done, and handle financial matters in a business-like manner.
  • The more business-like the arrangement the more likely you have an independent contractor relationship.

While there are no hard set rules, the more reasonable your basis for classification and the more consistently it is applied, the more likely an independent contractor classification will not be challenged.

Published: 01/29/2016 12:00 PM