Employee or Independent Contractor? Know the IRS Rules

It’s important for businesses and business owners to know the rules when it comes to classifying a worker as an employee or an independent contractor. This is especially true for tax purposes, as there are different reporting, taxation and withholding requirements for each.

As an employer, you must withhold income taxes and pay Social Security, Medicare taxes and unemployment tax on all wages paid to an employee. However employers usually do not have to withhold or pay taxes on payments to independent contractors.

Two key factors which determine whether or not the worker is an independent contractor or an employee are the degree of control the business has over the worker, and relationship between the employer and the worker:

  1. Control. The relationship between a worker and a business is key. 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 other relevant aspects aspects of the worker’s job, it exercises financial control. Some questions to think about:
  • To what degree has the worker invested in the facilities or tools used to perform services?
  • How does the business pay the worker?
  • To what extent does the worker makes his or her services available to the relevant market?
  • To what degree can the worker realize a profit or incur a loss?
  1. Relationship. The way in which the employer and worker see their relationship is also an important factor in determining the worker’s status. Factors include:
  • Written contracts describing the business relationship between the two parties
  • The permanency of the relationship
  • Whether the business provides the worker with typical employee benefits, like health insurance, life insurance, paid vacation days, sick pay or a retirement plan.
  • The extent to which services performed by the worker play an important role in the regular business operations of the company
  • The degree to which the worker has unreimbursed business expenses

Need more help? IRS Form SS-8 – Determination of Worker Status for Purposes of Federal Employment Taxes and Income Tax Withholding  – can guide you in determining the status of you workers. You may also want to take a look at  IRS Publication 15-A, Employer’s Supplemental Tax Guide – another very helpful resource.

If you need additional assistance with your business’ taxes, contact ProTax consulting.

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