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Employee vs. Independent Contractor

Do you have employees or independent contractors?  This is an important question with potentially large tax implications. Employees are paid through payroll and wages are subject to FICA and unemployment taxes.  Independent Contractors are not subject to payroll taxes, however there are additional reporting requirements for payments of services. This is also an area in which governments are beginning to crack down.  The IRS offers Form SS-8, which can be submitted by either the business or the worker to help determine the correct treatment in uncertain cases.  To help determine into which category your workers fall the IRS has some common law control rules that fall into three categories; behavioral, financial, and type of relationship.

The first category is behavioral control.  This refers to the degree of the right the company has to control the workers job.  An example of this is the type and degree of instructions given.  Generally, an employee is instructed about when, where, and how to work.  An independent contractor (IC) is hired to complete a job and given minimal instruction.  How the worker is evaluated is also a factor.  A contractor is usually only evaluated on the end result, rather than the parts of the process.  Training also factors in.  Training the worker on how to do the job it is strong evidence that the worker is an employee.  It is important to note that actually controlling these aspects of the worker are not important.  What's important is having the right to this control.

The second category of control is financial.  ICs often have significant investment in their equipment, whereas employees typically use the company's equipment.  ICs are usually not reimbursed for their expenses and will have ongoing expenses even if no work is being performed.  Whether the worker is offering their services to the market and not just to the company is strong factor for independent contractors.

The last category is the type of relationship.  This includes contracts, benefits, and length of the relationship.  Independent contractor agreements are always a good idea.  However, the existence of a contract is not sufficient to classify a worker as an IC.  Benefits such as insurance, paid time off, and retirement plans are indicators of an employee relationship, as these are generally not offered to ICs.  A company typically hires an IC with the expectation that the work will be for a specific job, or period.  If there is an expectation that the relationship will continue forever, it is evident of an employer-employee relationship.

It is important to look at the entire relationship between a company and the worker.  It is possible that some factors point to IC status while others point to employee.  You must consider all the factors and document the ones used to make the determination.  For help in making the determination or guidance on how to document it, please contact your trusted tax advisor.

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