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Employee vs. Independent Contractor?

In recent years, the Internal Revenue Service (IRS) has sought out and imposed severe penalties on companies that treat employees as independent contractors, and which fail to withhold taxes. To avoid the paperwork burden and expense of payroll taxes, some employers inappropriately designate workers "independent contractors." If the IRS determines that the worker is actually an "employee," the person responsible for the collection and payment of withholding taxes may be held personally liable for an amount equal to the taxes that should have been withheld.

An employer must generally withhold income taxes; withhold and pay social security and Medicare taxes; and pay unemployment taxes on wages paid to an employee. An employer does not generally have to withhold or pay any taxes on payments to independent contractors.

An organization must determine on a case-by-case basis whether an individual is an independent contractor or an employee.  The IRS uses three main considerations to distinguish between the two types:

  1. Behavioral control;
  2. Financial control, and
  3. Relationship between the parties.

Generally, individuals are considered employees if the organization controls what they do and how they do it.  For example, if the organization sets the individual's hours and requires the work to be performed in its offices, the IRS is likely to consider the individual to be an employee.  This would fall under the "behavioral control" consideration.

On the other hand, individuals who supply their own equipment and materials, and perform services for other companies are more likely to be considered independent contractors. This would fall under the  If there is a written contract between the organization and the individual, this would indicate contractor status. 

Prior to transitioning to the three considerations discussed above, the IRS used to consider 20 factors in determining a worker's status. Even though the IRS no longer uses this list, it still provides useful assistance in evaluating whether to consider an individual to be an employee vs. an independent contractor. Meeting just one of the conditions listed may qualify the worker as an employee. If a company is unable to determine the appropriate designation from the IRS guidelines, the IRS will help. Simply file a Form SS-8 and the IRS will respond with a determination. A summary of the IRS position and the 20 factors are provided below:

The 20 Factors - No Longer Determinative, But Still Useful

These factors should be considered general guidelines. Not every factor is applicable in every situation, and the degree of importance of each factor varies depending on the type of work and individual circumstances.

  1. Instructions. An employee must comply with instructions about when, where, and how to work. Even if no instructions are given, the control factor is present if the employer has the right to control how the work results are achieved.
  2. Training. An employee may be trained to perform services in a particular manner. Independent contractors ordinarily use their own methods and receive no training from the purchasers of their services.
  3. Integration. An employee's services are usually integrated into the business operations because the services are important to the success or continuation of the business. This shows that the employee is subject to direction and control.
  4. Services rendered personally. An employee renders services personally. This shows that the employer is interested in the methods as well as the results.
  5. Hiring assistants. An employee works for an employer who hires, supervises, and pays workers. An independent contractor can hire, supervise, and pay assistants under a contract that requires him or her to provide materials and labor and to be responsible only for the result.
  6. Continuing relationship. An employee generally has a continuing relationship with an employer. A continuing relationship may exist even if work is performed at recurring although irregular intervals.
  7. Set hours of work. An employee usually has set hours of work established by an employer. An independent contractor generally can set his or her own work hours.
  8. Full-time required. An employee may be required to work or be available full-time. This indicates control by the employer. An independent contractor can work when and for whom he or she chooses.
  9. Work done on premises. An employee usually works on the premises of an employer, or works on a route or at a location designated by an employer.
  10. Order or sequence set. An employee may be required to perform services in the order or sequence set by an employer. This shows that the employee is subject to direction and control.
  11. Reports. An employee may be required to submit reports to an employer. This shows that the employer maintains a degree of control.
  12. Payments. An employee is generally paid by the hour, week, or month. An independent contractor is usually paid by the job or on straight commission.
  13. Expenses. An employee's business and travel expenses are generally paid by an employer. This shows that the employee is subject to regulation and control.
  14. Tools and materials. An employee is normally furnished significant tools, materials, and other equipment by an employer.
  15. Investment. An independent contractor has a significant investment in the facilities he or she uses in performing services for someone else.
  16. Profit or loss. An independent contractor can make a profit or suffer a loss.
  17. Works for more than one person or firm. An independent contractor is generally free to provide his or her services to two or more unrelated persons or firms at the same time.
  18. Offers services to general public. An independent contractor makes his or her services available to the general public.
  19. Right to fire. An employee can be fired by an employer. An independent contractor cannot be fired so long as he or she produces a result that meets the specifications of the contract.
  20. Right to quit. An employee can quit his or her job at any time without incurring liability. An independent contractor usually agrees to complete a specific job and is responsible for its satisfactory completion, or is legally obligated to make good for failure to complete it.

Helpful links

http://www.irs.gov - look for Publication 1779

Sample Agreements

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