Do you use independent contractors to provide services to your business? They might not be independent contractors according to IRS rules. In fact, they might be considered employees by the IRS, and you could get into trouble if you’re not treating them as employees complete with necessary payroll tax payments, Medicare and Social Security withholdings, and all of the other things that go into managing an employee.
Differentiating Between Employees and Independent Contractors
According to the IRS, the determination of whether a person is an employee of a company or an independent contractor (typically a self-employed, sole proprietor) is based on evidence related to control and independence that is gathered in three areas: behavioral, financial, and type of relationship.
1. Behavioral
Behavioral considerations relate to instructions (how to perform the work and what tools to use to do the work), training (if the business provides training to teach how the job should be done), and evaluations (performance reviews of any kind). In simplest terms, if a person is required to perform a job in a specific way by the business, if the business trains the person to do the job, or the business evaluates the person’s work, then it’s likely that person would be viewed as an employee by the IRS.
You can learn more about behavioral considerations on the IRS website.
2. Financial
There are a variety of financial considerations that the IRS uses to determine if a person is an employee or independent contractor, including the person’s investment in equipment and tools to do the job for the business, unreimbursed expenses to do the job, and the opportunity to make a profit or experience a loss due to the person’s investment in equipment to do the job for the business.
Two of the easiest ways the IRS uses to determine if a person is an employee or independent contractor are related to how much work the person does for the business and how the person is paid. For example, a true independent contractor can have multiple sources of income and seeks out additional sources of income rather than obtaining his full income from a single business (making that business more of an employer than a client). Also, a true independent contractor is typically paid a flat fee on a project basis rather than on an hourly, weekly, or other time basis.
You can learn more about financial considerations on the IRS website.
3. Type of Relationship
There are a variety of factors considered by the IRS to determine the type of relationship a person has with a company when classifying that person as an employee or independent contractor. Some of these relate to contracts and benefits, but two of the factors that trip up businesses and get them in trouble with the IRS most often are related to the permanency of the relationship and the importance of the services performed by the person.
For example, if the relationship between the business and the person performing services is expected to continue indefinitely, rather than on a project basis, it’s likely that person would be viewed as an employee by the IRS. Furthermore, if the tasks performed by the person are key to the business, that person will probably be considered an employee by the IRS.
You can learn more about relationship considerations on the IRS website.
Next Step for Businesses
The IRS offers a form that you can submit to determine if a person is an employee of your business or an independent contractor (Form SS-8, Determination of Worker Status for Purposes of Federal Employment Taxes and Income Tax Withholding). It can take six months for the IRS to complete it’s review.
Once you get the appropriate determination, you’ll know the steps you need to take to be in compliance with IRS regulations related to employees versus independent contractors. You’ll also know whether you should file tax forms for employees or tax forms for independent contractors.
Many large and small companies have been required to pay fines and reclassify workers after the IRS reviewed the use of employees versus independent contractors at those companies. Some larger companies have even ended up in class action lawsuits and paid sizable settlements. Don’t risk the same fate. Do your due diligence and classify your workers correctly now to avoid fines and trouble later.
Susan Gunelius
Susan Gunelius is the Founder and Editor-in-Chief of Women on Business. She is a 30-year veteran of the marketing field and has authored a dozen books about marketing, branding, and social media, including the highly popular Ultimate Guide to Email Marketing, 30-Minute Social Media Marketing, Content Marketing for Dummies, Blogging All-in-One for Dummies and Kick-ass Copywriting in 10 Easy Steps. Susan’s marketing-related content can be found on Entrepreneur.com, Forbes.com, MSNBC.com, BusinessWeek.com, and more. Susan is President & CEO of KeySplash Creative, Inc., a marketing communications company. She has worked in corporate marketing roles and through client relationships with AT&T, HSBC, Citibank, Intuit, The New York Times, Cox Communications, and many more large and small companies around the world. Susan also speaks about marketing, branding and social media at events around the world and is frequently interviewed by television, online, radio, and print media organizations about these topics. She holds an MBA in Management and Strategy and a Bachelor of Science degree in Marketing and is a Certified Professional Career Coach (CPCC).
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Excellent post about differences between independent contractors or employees!
That is true, IRS is always watching! 🙂
From what I understood about it too is that if they’re an independent contractor, make sure that they have other lines of income from working for other companies. If you’re the only one that is ’employing’ them for work, then in the eyes of the IRS, you’re their employer, and can be sued for back taxes.
Butttt I’m also no employment attorney. Best to get it checked out with them. 😉 But this is really great insight on this, Susan! I learned a few new things. 🙂
Devan, I’ve heard that same rule of thumb — if a contractor is working for just one company, then it’s probably an employer-employee relationship.