An often asked question in the tax and labor area is whether a worker should be considered an employee or an independent contractor. The difference in characterization can have serious implications for both the worker and the hiring party. If a worker is considered an employee, there are significant tax consequences. Employers are required to pay social security taxes (FICA), unemployment taxes (FUTA), and are required to withhold social security and income taxes (Federal, state and local) from employee wages. By contrast, the hiring of an independent contractor does not carry with it many of these tax and recordkeeping burdens. Self-employed persons who work as independent contractors are required to make their own estimated income tax payments and self-employment social security tax contributions (SECA).
Whether a person is characterized as an employee or as an independent contractor also has non-tax consequences. Workers who might otherwise be required to be included in employee benefit plans or group insurance programs often can be excluded if they are truly independent contractors. In addition, independent contractors usually are not subject to (and are not covered by) an employer’s worker’s compensation policy.
Because of the significant economic consequences at stake, workers and their potential employers often go out of their way in an attempt to characterize the relationship as an independent contractor arrangement. These efforts have not been lost on the Internal Revenue Service, however, and the IRS has developed a comprehensive list of factors to be considered in determining whether a person is an employee or an independent contractor. Not surprisingly, most of these factors negate a finding of independent contractor status.
Here is a list of some of the more important factors utilized by the IRS in making this determination:
- Employees are controlled and directed by the employer as to how they work and as to the end result; independent contractors have freedom to determine the best means to achieve the hiring party’s goals.
- Employees must perform services personally and cannot delegate their duties; not so for many independent contractors.
- Employees often receive employer training, whereas independent contractors are already trained.
- Employment is generally continuing whereas independent contractors are usually sporadic and of a shorter duration.
- Employees have fixed hours.
- Independent contractors often have multiple employers and their services are available to the general public in most cases.
- Independent contractors have a potential economic risk of loss in their contract arrangement whereas employees receive “guaranteed” wages regardless of result.
The IRS has become relatively aggressive in enforcing the distinction between employment status and independent contractor status. As the foregoing list of factors indicates, it is difficult to meet the independent contractor test. Because of the consequences in mischaracterizing the relationship, prudence dictates a careful review of these and other factors to insure that the work relationship is properly structured and accounted for.
— BBC&B