Employee or Independent Contractor?
Many business owners fail to recognize the effect of misclassifying a worker as an employee versus an independent contractor. Properly classifying such a worker as an independent contractor saves money for your organization. However, if you have misclassified the individual, you could expose yourself to significant tax liabilities.
An employer must generally withhold federal, state and local income taxes, withhold and pay social security and Medicare taxes mandated under the Federal Insurance Contribution Act (FICA), and pay unemployment tax on wages paid to an employee required under the Federal Unemployment Tax Act (FUTA), pay any state unemployment insurance tax and pay any workers’ compensation fees. Employee status also required filing a number of returns during the year with various taxing authorities and providing W-2s to all employees by January 31st. Additionally, an employee may also have rights to benefits such as vacation, holidays, health insurance or retirement plans.
An employer generally does not have to withhold or pay any taxes on payments to independent contractors.
To determine whether an individual is an employee or an independent contractor under the common law, the relationship of the worker and the business must be examined. In any employee-independent contractor determination, all information that provides evidence of the degree of control and the degree of independence must be considered.
Facts that provide evidence of the degree of control and independence fall into three categories: behavioral control, financial control and the type of relationship of the parties.
Facts that show whether the business has a right to direct and control how the worker does the task for which the worker is hired include the type and degree of instructions that the business gives to the worker. An employee is generally subject to the business's instructions about when, where and how to work. The following are examples of types of instructions about how to do work:
- 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.
Although the amount of instruction needed varies among different jobs, generally the more detailed the instructions, the more control the business has over the worker.
Even if no instructions are given, sufficient behavioral control may exist if the employer has the right to control how the work results are achieved. A business may lack the knowledge to instruct some highly specialized professionals; in other cases, the task may require little or no instruction. The key consideration is whether the business has retained the right to control the details of a worker's performance.
Training that the business gives to the worker. An employee may be trained to perform services in a particular manner. Independent contractors ordinarily use their own training methods.
Facts that show whether the business has a right to control the business aspects of the worker's job include:
- The extent to which the worker has unreimbursed business expenses. Independent contractors are more likely to have unreimbursed expenses than are employees. Fixed ongoing costs that are incurred regardless of whether work is currently being performed are especially important. However, employees may also incur unreimbursed expenses in connection with the services that they perform for their business.
- The extent of the worker's investment. An independent contractor often has a significant investment in the facilities he or she uses in performing services for someone else. However, a significant investment is not necessary for independent contractor status.
- The extent to which the worker makes his or her services available to the relevant market. An independent contractor is generally free to seek out business opportunities. Independent contractors often advertise, maintain a visible business location, and are available to work in the relevant market.
- How the business pays the worker. An employee is generally guaranteed a regular wage amount for an hourly, weekly or other period of time. This usually indicates that a worker is an employee, even when the wage or salary is supplemented by a commission. An independent contractor is usually paid by a flat fee for the job. However, it is common in some professions, such as law, to pay independent contractors hourly.
- The extent to which the worker can realize a profit or loss. An independent contractor is more likely to incur a financial loss on a job.
Type of Relationship
Facts that show the parties’ type of relationship include:
- Written contracts describing the relationship the parties intended to create.
- Whether the business provides the worker with employee-type benefits, such as insurance, a pension plan, vacation pay or sick pay.