When should an individual be treated as an employee and when should they be treated as an Independent Contractor?
- When someone is an employee they are paid through the payroll system; taxes are withheld and the employer is responsible for benefits.
- When someone is an independent contractor, they are not on the payroll, taxes are not withheld from their payments and their income is reported as nonemployee compensation on Form 1099-Misc (if payments exceed $600). The party making the payment is not required to provide benefits.
How do we determine if an individual is an employee or Independent Contractor?
- To make this determination we must examine the relationship of the worker and the business. The main focus of this examination is control and independence. This usually falls into three categories:
- Behavioral Control
- Financial Control
- Type of Relationship
Does the business have the right to direct and control how the worker does the task for which they are hired?
What is the level of instruction that the business gives the worker?
The more defined these instructions are, the more likely the worker is an employee. These instructions could include, but are not limited to:
- When and where to do the work
- What tools or equipment to use
- What workers to hire or assist with work
- Where to purchase supplies and services
- What work must be performed by a specified individual
- What order or sequence to follow
Even if no instruction is given, sufficient behavioral control may exist if the employer has the right to control how the work results are achieved. The key is whether or not the business has retained the right to control the details of a worker's performance.
Does the business provide any training to the worker?
Normally an employee is trained to perform services in a particular manner. Independent contractors ordinarily use their own methods.
Does the business have the right to control the business aspects of the worker's job?
Does the worker have unreimbursed expenses?
Independent contractors are more likely to have unreimbursed expenses than employees.
Does the worker incur fixed ongoing costs regardless of whether the work is currently being done?
Yes to this question indicates the worker is an independent contractor.
Does the worker have a significant investment in the facilities he or she uses in performing services for someone else?
If yes, then the worker is normally an independent contractor. However, the lack of a significant investment in facilities does not automatically mean the worker is an employee.
Does the worker make his or her services available to other businesses?
This is a clear indication of independent contractor status. Often times an independent contractor will advertise maintain a viable business location and make themselves available to other businesses.
Is the worker paid a regular wage?
An employee is generally guaranteed a regular wage amount for a set period of time - hourly, weekly, monthly, etc. An independent contractor may be paid based on a per job basis, or can also be paid by the hour.
Can the worker incur a profit or loss?
An independent contractor can make a profit or loss on the work/job.
TYPE OF RELATIONSHIP:
What is the relationship between the business and the worker?
Is there a written contract between the business and the worker that describes the relationship intended between the two parties?
Does the business provide the worker with employee-type benefits, such as insurance, a pension plan, vacation and/or sick pay?
If so, the worker has the characteristic of an employee.
What is the permanency of the relationship?
If the worker is given the expectation that the relationship will continue indefinitely, rather than for a specific project or period, then it is more likely that the intent was to establish an employer/employee relationship.
Are the services performed by the worker a key aspect of the regular business of the company?
If the services provided by the worker are considered a key aspect of the business' regular activities, it is more likely that the business will have the right to direct and control his or her activities. The ability to direct and control the activity is a characteristic of an employer/employee relationship.
Generally there is an employer/employee relationship when the person for whom services are performed has the right to control and direct the individual who performs the services, not only as to the result to be accomplished but also as to the details and means by which the result is accomplished. In this connection, it is not necessary that the employer actually direct or control the manner in which the services are performed; it is sufficient if the employer has the right to do so.
The IRS developed 20 factors to assist in determining if a worker is an Employee or Independent Contractor:
A "Yes" answer for the following questions indicates that the worker is an employee:
- Does the business provide instructions to the worker about when, where and how he or she is to perform the work?
- Does the business provide training to the worker?
- Are the services provided by the worker integrated into the business' operations?
- Must the services be rendered personally by the worker?
- Does the business hire, supervise and pay assistants to the worker?
- Is there a continuing relationship between the business and the worker?
- Does the business set the work hours and schedule?
- Does the worker devote substantially full time to the work of the business?
- Is the work performed on the business' premises?
- Is the worker required to perform the services in an order or sequence set by the business?
- Is the worker required to submit oral or written reports to the business?
- Is the worker paid by the hour, week or month?
- Does the business have the right to discharge the worker at will?
- Can the worker terminate his or her relationship with the business any time he or she wishes without incurring liability to the business?
- Does the business pay the traveling expenses of the worker?
A "Yes" answer for the following questions indicates that the worker is an Independent Contractor:
- Does the worker furnish significant tools, materials and equipment?
- Does the worker have a significant investment in the facilities?
- Can the worker realize a profit or loss as a result of his or her services?
- Does the worker provide services for more than one business at a time?
- Does the worker make his or her services available to the general public?
- The determination of whether a worker is an employee or independent contractor is the responsibility of the business.
- If the IRS challenges the classification made by the business, the burden of proof is on the taxpayer (business).
- If requested, the IRS will make a determination of whether a worker is an employee or independent contractor. This request is done by filing Form SS-8, Determination of Employee Work Status for Purposes of Federal Employment Taxes and Income Tax Withholding.