Employee or Independent Contractor?

An important question small business have is whether someone is an employee or independent contractor. Fortunately, the IRS provides some guidance to make this distinction. This distinction is important because “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.”

If you hire or contract individuals to provide services to your business, “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.”

The IRS lists three categories to provide evidence of the degree of control and independence:

  1. Behavioral: Who controls what the worker does and how the worker does their job?
  2. Financial: Is the worker’s business aspects of their job controlled by the payer?
  3. Relationship type: are there employee benefits offered to the worker (insurance, pension, etc.)? Does a contract exist?

Individual situations may not be clear, so the IRS advises “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.”

If the situation remains unclear, a worker or business can file a Form SS-8, Determination of Worker Status for Purposes of Federal Employment Taxes and Income Withholding. This form will allow the IRS to review the work arrangement and make an official determination whether the worker is an employee or independent contractor.

As with all business decisions, it is important to seek guidance and advice from your legal or tax advisor.