Contractor versus employee – be sure you’re using the correct classifications for your staff!
You probably already know the primary difference when it comes to contractor versus employee. You only pay contractors or freelancers a fee for their work. While with employees, you’re also responsible for employment taxes and often other benefits.
Control and independence
The IRS itself states that “…there is no ‘magic’ or set number of factors that ‘makes’ the worker an employee or an independent contractor.” And you can’t use just one factor to make the determination. For example, you can’t call an individual an independent contractor simply because he or she works out of a home office instead of yours. Rather, you have to look closely at the whole relationship between your company and them. You need facts. In addition, you need to consider the “…degree of control and independence” involved, in three different categories.
Behavioral control – contractor versus employee
Do you as the employer have the right to control how the individual works? In general, there are four ways to measure that:
- Type of instructions given. Do you tell the individual how, when, and where to work? What equipment to use? Where to buy supplies and services? What sequence to follow?
- Degree of instruction. How detailed are the instructions?
- Evaluation system. How do you evaluate the worker? Do you evaluate how he/she does the work or just the end result?
- Training. Do you offer initial and periodic training, or is the individual responsible for his or her own?
Financial control – contractor versus employee
There are several questions to consider here. Does the individual:
- Pay for a significant percentage of the equipment used?
- Have a lot of unreimbursed expenses?
- Have the opportunity to make a profit or loss?
- Feel free to work for other businesses?
- Generally receive consistent wages for each pay period?
Type of relationship – contractor versus employee
How would you and the individual characterize your relationship with each other? Do you have a written contract? Do you offer employee benefits? Also, did you hire him or her expecting that the relationship would go on indefinitely? Furthermore, are the individual’s contributions to the company a “key activity” of the business?
As you can see, it’s more complicated than you might think. In addition, the IRS takes this issue very seriously, and has been known to follow up with companies where at least some of the classifications were suspected to be in error. Hence, it is important to give proper attention to this issue.
The Form SS-8
If you still can’t determine whether an individual is an employee or independent contractor after going through all the above questions, you–or someone who works for you–can complete and file an IRS Form SS-8. This is a rather lengthy document designed to help determine a worker’s employment status.
We’re always available to consult with you on various issues of tax law. Request a free consultation or call us at 832-919-8448.