Employee or Independent Contractor
Employee or independent contractor: sometimes it's difficult to know what camp your workers fall into. But when you consider health benefits, compensation, and tax responsibilities, knowing the difference between the two is an absolute necessity. But what exactly are the differences between employee status and being an independent contractor?
Under common law rules, workers are employees if the hiring party has the right to direct and control them in the way they work, including final results and details of when, where and how the work is done. Generally speaking, the IRS will look at three categories of control in order to determine if there is sufficient control to warrant classifying the workers as employees. The three categories are:
- Behavioral Control: do you have the right to control how your worker performs a certain task? Yes? Your worker may be an employee then.
- Financial Control: if you direct or control how the worker conducts the business aspects of his activities, you may have hired an employee.
- Relationship of the Parties: how do you and your worker(s) perceive your relationship? Employee benefits, written contracts, discharge and termination aspects and your regular business activity are some indicators considered.
The IRS has also published a list of 20 factors that its auditors use as guidelines to make a proper determination. These factors, in general, are more objective than the above common law behavioral categories. So, without further ado, here are the "Big Twenty":
- Instructions: If workers must comply with your instructions as to when, where, and how to work they are probably employees.
- Training: If you provide or in the past have provided training to workers, they are probably employees. Why? Independent contractors are supposed to know how to do their work and therefore shouldn't need training from someone purchasing their services.
- Integration: The more integral your worker's services are to your business' success, the more likely the worker performing those services is an employee.
- Services Rendered Personally: Must a particular worker personally perform the services in question or does the worker have the right to substitute other people's services for his own fulfillment of a contract? If the former, then he is probably an employee, if the latter, then he is probably an independent contractor.
- Hiring Assistants: Are your workers in charge of hiring, supervising, and paying their own assistants? If yes, then they are probably independent contractors. If no, they are probably employees.
- Continuing Relationship: The longer the time period or the more recurring intervals during which services are performed, the more it will appear to be an employer – employee relationship.
- Set Hours of Work: If workers can set their own hours there is a greater chance of them being independent contractors. If you establish set hours of work for them, they are more likely to be considered employees.
- Work Done on Premises: If workers must work on your premises or a place designated by you, they are more likely employees. Independent contractors usually have their own place of business where they can do their work for you.
- Full-Time: Independent contractors usually can work whenever and for whomever they want. In contrast, if you require them to be available full-time, they will more likely be considered your employees.
- Set Order or Sequence: If you are setting the order or sequence in which workers perform the services in question, the IRS will more likely see those workers as employees.
- Reports: If you require your workers to submit their reports to you, then your relationship is more likely one of employer - employee.
- Payment Method: Workers paid by the job are more likely independent contractors; those paid by week or by month are more often seen as employees.
- Expenses: Most independent contractors are expected to cover their own overhead expenses (in the absence of a contrary contractual agreement). Workers whose business and travel expenses are paid by you are more likely to be employees.
- Tools and Materials: Independent contractors usually supply their own tools, materials, and equipment, whereas those using your tools, equipment, etc. are more likely to be your employees.
- Investment: The greater your workers' investment in materials they use to do their work, the more likely they can be classified as independent contractors.
- Profit or Loss: The greater the risk that workers can either make a profit or suffer a loss in doing their work, the greater likelihood that they should be classified as independent contractors.
- Works for More Than One Person/Entity at a Time: The more entities your worker works for at any one time, the more likely he is an independent contractor. If he works only for you, that scenario lends itself more to an employee classification.
- Services Available to the General Public: Meaning if your worker advertises his own services through business cards, print advertisement, promotional items, etc., he is more likely to be performing them as an independent contractor than as an employee.
- Right to Fire: Workers you can fire at any time are more likely employees. The right to terminate independent contractors however, is usually limited by specific contractual terms.
- Right to Quit: Workers who can quit at any time without any risk of liability are probably employees (they have less investment and less control). Independent contractors usually cannot walk away in the middle of a project without being financially accountable.
Remember: one factor only and by itself will not necessarily determine the classification. A tax professional can help you make this determination. The IRS will also, on request, provide you with a determination. The key is to ask for it before an auditor shows up at your door.