The IRS's Position
In my last article entitled "Employees and Independent Contractors - What's the Difference?" I pointed out that one important reason for a business owner to know whether a worker is an employee or an independent contractor is that an employer is legally responsible for the negligence of his employees, but he's not responsible for the negligence of an independent contractor. Here's what the IRS has to say about the difference between employees and independant contractors from a taxation point of view.
It is critical that you, the employer, correctly determine whether the individuals providing services are employees or independent contractors. Generally, you must withhold income taxes, withhold and pay Social Security and Medicare taxes, and pay unemployment tax on wages paid to an employee. You do not generally have to withhold or pay any taxes on payments to independent contractors.
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 (1) An independent contractor (2) An employee (common-law employee) (3) A statutory employee or (4) A statutory non-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 must be considered.
Facts that provide evidence of the degree of control and independence fall into three categories:
Behavioral: Does the company control or have the right to control what the worker does and how the worker does his or her job? In general, anyone who performs services for you is your employee if you can control what will be done and how it will be done. This is so even when you give the employee freedom of action. What matters is that the employer has the right to control the details of how the services are performed. Such details include:
When and where to do the work
What tools or equipment to use
What workers to hire or to assist with the work
Where to purchase supplies and services
What work must be performed by a specified individual
What order or sequence to follow
Financial: Are the business aspects of the worker’s job controlled by the payer? Are there unreimbursed expenses that the worker has to bear themselves? Are the worker’s services available to the public? What is the method of payment; do they get paid whether the work is done or not or do they get paid only if they finish the job? Independent contractors can realize a profit or loss on a job. Can the worker make business decisions that affect his bottom line?
Type of Relationship: Are there written contracts or employee type benefits (i.e. pension plan, insurance, vacation pay, etc.)? Will the relationship continue indefinitely or only for a specific project or period. Also, does the worker have his own business, which he markets to others?
Businesses must weigh all these factors when determining whether a worker is an employee or 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 “magic” or 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 which are relevant in one situation may not be relevant in another.
The keys are to look at the entire relationship, consider the degree or extent of the right to direct and control, and finally, to document each of the factors used in coming up with the determination.
