Independent Contactor or Employee – How do you know?
MSL SafeSource Accounting Solutions – Orlando, FL
This is an important topic for business owners: How to determine if the worker is an employee or an independent contractor? The real question becomes, “How do you know?” Generally, you must withhold income taxes, withhold and pay Social Security and Medicare taxes, and pay unemployment taxes on wages paid to an employee. You do not have to withhold or pay any payroll taxes on payments made to independent contractors. The Internal Revenue Service (IRS) implements the Common Law Rules to help distinguish the difference between independent contractor and employee.
Before you can determine how to treat payments you make for services, you must first know the business relationship that exists between you and the person performing the services. The person performing the services may be:
- An independent contractor,
- or An employee.
In determining whether the person providing service is an employee or an independent contractor, all information that provides evidence of the degree of control and independence that a worker has must be considered.
Common Law Rules are facts that provide evidence to what degree of control or independence the worker has. The IRS historically used a 20-factor test. Now there are only three categories to consider.
- Behavioral: Does the company control or have the right to control what the worker does and how the worker does his or her job?
- Financial: Are the business aspects of the worker’s job controlled by the payer? These include things like how the worker is paid – being paid by the hour is indicative of employee status vs. a single payment to complete the job is favorable to contractor status; whether expenses are reimbursed, who provides tools, supplies, etc.
- Type of Relationship: Are there written contracts or employee-type benefits (i.e. insurance, pension plan, and vacation pay)? Will the relationship continue, and is the work performed a key aspect of the business?
Businesses must weigh all these factors when determining whether a worker is an employee or an independent contractor. Some factors may indicate that the worker is an employee while other factors indicate that the worker is an independent contractor. There is no set number of factors that makes the worker an employee or an independent contractor, and no one factor stands alone in making this determination. Also, factors that are relevant in one situation may not be relevant in another.
What happens if you misclassified an employee or independent contractor? If you classify an employee as an independent contractor and you have no reasonable basis for doing so, you may be held liable for employment taxes for that worker (relief provisions will not apply). However, the Voluntary Classification Settlement Program (VCSP) is a new optional program that provides taxpayers with an opportunity to reclassify their workers as employees for future tax periods for employment tax purposes with partial relief from federal employment taxes for eligible taxpayers that agree to prospectively treat their workers as employees. To participate in this program, the taxpayer must meet certain eligibility requirements.
If you have further questions or need additional information, please feel free to contact an MSL SafeSource Professional at 407.740.5400. We will be delighted to assist you in this matter.