A business that hires workers needs to know the difference between an employee and an independent contractor. These two workers might do the same or similar work, but there are key legal differences between them. Employers must determine whether their workers are employees or independent contractors to avoid having problems with the IRS.

Employee or independent contractor?

Generally, an employee is anyone who performs services for a business when the business can control what the worker does. The key here is the business has the right to control how the worker’s services are performed. It doesn’t matter that the business hasn’t actually exerted that control. On the other hand, independent contractors are workers who have their own trade, business, or profession and offer their services to the public.

Relationship between worker and business.

A worker is either an employee or an independent contractor, depending on their relationship with the business. To determine what the relationship is, the IRS asks the following questions:

• Does the company control, or have the right to control the details of what the worker does and where and how they do it?
• Does the business direct or control the financial and business aspects of the worker’s job? A job’s financial and business aspects include how the worker is paid and whether the business reimburses expenses, provides tools, supplies, an office, and so on.
• Does the worker have a written contract? What does it say about the business’ control over the worker? Is the worker’s contract short-term or will the worker’s relationship with the business continue? Is the work performed a key aspect of the business?
• Is the worker entitled to employee-type benefits such as a pension, health insurance, or vacation pay?

Misclassified worker

Generally, an employer must withhold and pay income taxes, Social Security and Medicare taxes, and unemployment taxes. If a business misclassifies an employee as an independent contractor, the employer doesn’t pay its share of the worker’s employment taxes, and the employee’s share isn’t withheld.

Note. In the event a business misclassifies an employee, the business can be liable for employment taxes for that worker.

Workers who believe they have been improperly classified as independent contractors should ask the IRS to determine their worker status. Workers who receive a determination of worker status from the IRS can use Form 8919, Uncollected Social Security and Medicare Tax on Wages to figure and report their share of uncollected Social Security and Medicare taxes due on their compensation.

Voluntary classification settlement program.

If a business thinks it has misclassified a worker (or workers) it can come clean to the IRS by participating in the IRS’s Voluntary Classification Settlement Program. The VCSP allows businesses to reclassify their workers as employees for future employment tax purposes. It also offers partial relief from federal employment taxes for eligible businesses that agree to prospectively treat their workers as employees.

To participate in the VCSP, businesses must meet certain eligibility requirements and apply by filing Form 8952, Application for Voluntary Classification Settlement Program, and entering into a closing agreement with the IRS.

Independent contractors are self-employed. Generally, independent contractors are self-employed if any of the following apply to them:

• They carry on a trade or business as a sole proprietor or a single-member LLC;
• They are a member of a partnership (or an LLC taxed as a partnership) that carries on a trade or business; or
• They are otherwise in business for themselves, including a part-time business.

Note: Individuals who do business as a single-member S corporation are employees of the S corporation.

Independent contractors who provide services for other businesses, including those who earn money from gig economy work, are considered to be self-employed and not employees of the businesses they do work for. Usually, these individuals are required to pay their own income, Social Security, and Medicare taxes by making estimated quarterly tax payments.

If you have questions about this topic, contact John Olson, a manager in the integrated services department at Isdaner & Company, LLC.