The legal distinction between an employee and an independent contractor has confused and frustrated business owners, attorneys, and accountants for many years. The purpose of this article is to provide some guidance for business owners and explain why it is important to correctly classify workers.
If you are a business owner, it is to your advantage from a tax perspective if every person who works for you is an independent contractor. By utilizing independent contractors rather than employees, you do not have to pay social security and unemployment taxes on their wages, nor do you have to collect and account for withholding taxes. The administrative burden and paperwork involved in using independent workers is far less burdensome.
As a business owner, you are responsible for classifying your workers as independent contractors or employees. The Internal Revenue Service (“IRS”) may dispute your classification. If the IRS concludes you have incorrectly classified a worker as an independent contractor, then typically you (not the worker) will pay the consequences. You will be responsible for all the social security and income taxes (plus interest) that you would have paid or withheld for those workers had you correctly classified them. As you can imagine, the consequences can be financially devastating, particularly if the mistaken classifications have been in effect for several years and involve multiple individuals.
Because of this risk, it is essential that business owners understand whether a worker is an employee or an independent contractor. Unfortunately, there are no precise rules and each case is determined on its own facts and circumstances. The IRS has published guidelines, including a 20-factor test, discussing the distinctions between employees and independent contractors.
Factors that suggest an employer-employee relationship include the following:
- training a worker to do a job in a particular way;
- instructing a worker as to where, when, and how to work;
- requiring the worker to devote substantially all of his or her time to your business;
- paying the worker by the hour, week, or month (as opposed to a contract price); and
- providing the worker with tools, materials, and other forms of assistance.
Factors that suggest an independent contractor relationship include the following:
- the worker works for many different people and chooses when to perform services for you; and
- the worker provides his or her own tools and materials;
- the worker pays his or her own business expenses; and
- the worker performs his or her job with little or no supervision or control.
While no single factor controls, the IRS and courts often focus on the control issue (i.e., the extent to which the business owner controls the working conditions and output of the worker). The more control a business owner exercises over a worker, the more likely the worker will be deemed an employee.
In short, determining whether someone is an employee or an independent contractor is not always easy, and you should consult an attorney or accountant for guidance if you have questions.
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