Employee vs. Independent Contractor - Tips for Business Owners

Article Highlights:

• Independent Contractor Cost Savings
• Primary Determining Factors
• Additional Determining Factors
• Penalties for Misclassification
• Requesting the IRS to Make the Determination

If you are a small business owner, whether you hire people as independent contractors or employees will impact the amount of taxes you withhold from their paychecks as well as how much and what types of taxes you pay. Furthermore, it will affect how much additional cost your business must bear, what documents and information must be provided to you, and what tax documents must be given to the individuals you are hiring.

Worker misclassification is a perennial issue for the Internal Revenue Service and state taxing authorities due to the perception that many employers are not properly classifying their workers.

The obvious advantage for a business to treat an individual as an independent contractor is to avoid paying minimum wages, overtime, payroll taxes, worker’s compensation insurance, unemployment tax, Social Security contributions, health benefits, paid leave, 401(k) benefits, and unpaid leave under the Federal Family and Medical Leave Act. Workers also have some tax-related benefits to being considered independent contractors, such as the ability to deduct certain business expenses that are not available to employees, the eligibility to set up their own retirement plans, and the fact that they are not subject to withholding. Of course, many workers want to be considered employees so they can get the benefits due to employees, such as vacation pay, overtime pay, and health insurance.

Here are some things every business owner should know about hiring people as independent contractors versus hiring them as employees.

Three characteristics are used by the IRS to determine the relationship between businesses and workers:

• Behavioral Control - Behavioral control covers facts that show whether the business has a right to direct or control how the work is done through instructions, training, or other means.
• Financial Control - Financial control covers facts that show whether the business has a right to direct or control the financial and business aspects of the worker's job.
• Type of Relationship - This type of relationship factor relates to how the workers and the business owner perceive their relationship.

If you have the right to not only control or direct what is to be done but also how it is to be done, then your workers are most likely employees.

If you can direct or control only the result of the work done, and not the means and methods of accomplishing the result, then your workers are probably independent contractors.

Employers who misclassify workers as independent contractors can end up with substantial tax bills. Additionally, they can face penalties for failing to pay employment taxes and not filing the required tax forms. Employers can request the IRS to make a determination on whether a specific individual is an independent contractor or an employee by filing Form SS-8 (Determination of Worker Status for Purposes of Federal Employment Taxes and Income Tax Withholding) with the IRS. A worker may also file Form SS-8 requesting an IRS determination. The IRS does not issue determinations for proposed or hypothetical situations.

If you need more information about the critical determination of a worker’s status as an independent contractor or employee, please give this office a call.