There is often a fine line between an employee and an independent contractor. When should a worker be considered an employee or an independent contractor? The distinction between the two can have significant implications for both the worker and the business owner.
An employer is required to withhold social security and income taxes from an employee’s pay check as well as to pay social security and unemployment taxes. Those amounts are based on the amount paid to the employee. By hiring an independent contractor, however, a business owner avoids most of the tax burdens and the recordkeeping responsibilities that are associated with employees. Self-employed people who work as independent contractors are required to pay their own estimated income tax payments and self-employment social security tax contributions.
In addition to the tax obligations associated with employing workers, business owners are also faced with non-tax liabilities of employees. Businesses that offer employee benefits or group insurance programs may be required to include all employees, whereas hiring independent contractors can reduce or avoid the administration and expense of such programs. In addition, independent contractors usually are not subject to an employer’s workers’ compensation policy.
Due to the considerable economic consequences at stake, business owners often go out of their way to portray a worker’s relationship as that of an independent contractor rather than as a more costly “employee” relationship. The Internal Revenue Service is mindful that business owners have an incentive to characterize workers as independent contractors. The IRS has developed a broad list of factors it considers when determining whether a worker is truly an independent contractor or is an employee. Not surprisingly, most of the factors the IRS uses negate a finding of independent contractor status.
Some of the factors used by the IRS in making such a determination include:
Whether workers are controlled and directed by the business owner as to how they perform their tasks; independent contractors have greater freedom to determine the best means to achieve the hiring party’s goals.
Whether workers receive employer training; independent contractors are viewed as already trained.
Whether the employment is generally continuing; independent contractor arrangements are usually sporadic and of shorter duration.
Whether there are fixed hours; independent contractors can usually come and go as they please.
Whether a worker is beholden to one business owner; independent contractors often have multiple contracts and their services are usually available to the general public.
Whether tools and equipment are provided by the business owner; independent contractors usually come to a job with their own tools and equipment.
Whether a worker receives “guaranteed” wages; independent contractors have a potential economic risk of loss in their contract arrangement.
The IRS is aggressive in enforcing the distinction between employment status and independent contractor status. As the list above indicates, it is difficult for a worker to meet the independent contractor test if they do not truly meet the criteria set forth above. The IRS, state and local taxing bodies as well as benefit providers have serious penalties for owners that are found to be classifying workers as independent contractors when they may really be employees. Because of the severe consequences in mischaracterizing the relationship, prudence dictates a careful review of these and other factors to insure that the work relationship is properly structured. If you are concerned about the question, contact our office for assistance in reviewing independent contractor arrangements so as to avoid needless sanctions.
– J .Ken Butera