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Do You Know Your Independent Contractors From Your Employees?

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difference between independent contractors and employees

States are cracking down on companies that misclassify their employees as independent contractors, Bloomberg reports. Labeling someone an independent contractor means companies don’t have to withhold or pay income taxes, Social Security and Medicare taxes or unemployment taxes.

But revenue-hungry states are looking more closely into worker classification in an effort to get tax payments from employers.

Of course, many misclassifications happen due to honest error, because the line dividing employee from independent contractor is often hazy. Do you know the difference between independent contractors and employees?  Below are the guidelines you need to know.

In general, the IRS considers someone an independent contractor if your business has the right to control or direct only the result of the work you hire them to do, but not what will be done and how it will be done.

The IRS bases the determination on three criteria:

Behavioral

Is the work actually done on your premises? Do you provide the equipment or tools needed to do the work? Do you instruct the person on a daily basis?

If so, they are more likely an employee. On the other hand, if the person works at his or her office, using his or her equipment and decides how the work will be done, they’re more likely an independent contractor.

Financial

Does the person buy the equipment or tools to do the work? Does he or she handle the expenses involved (such as buying supplies or paying a phone bill), or do you reimburse the person? Do you pay the person a salary or do you pay per project? Are you the person’s sole source of income or does he or she do the same type of work for other clients?

Relationship

Do you have a contract with the person? If so, does it specify a beginning and ending date for the relationship, or focus on a specific project to be delivered? If so, the person is more likely to be an independent contractor.

Do you provide benefits to the person, such as life or health insurance or paid time off? If so, the person is more likely to be an employee.

Clearly, there are lots of gray areas here. If you have doubts about how to classify someone, talk to your accountant and if you are still uncertain, file Form SS-8 (PDF), Determination of Worker Status for Purposes of Federal Employment Taxes and Income Tax Withholding, with the IRS.

They’ll determine the worker’s status, which can take up to six months, but will put your mind at ease.

Apple Orange Comparison Photo via Shutterstock

8 Comments ▼

Rieva Lesonsky Rieva Lesonsky is a Columnist for Small Business Trends covering employment, retail trends and women in business. She is CEO of GrowBiz Media, a media company that helps entrepreneurs start and grow their businesses. Follow her on Google+ and visit her blog, SmallBizDaily, to get the scoop on business trends and free TrendCast reports.

8 Reactions
  1. I guess companies love to brand their employees as independent contractors as it helps them cut out some taxes. This is a great way to tell if a person is an employee or an independent contractor. It can also help the government get the right amount of taxes from a company.

  2. Whether employees or independent contractors, they both help in nation building by working for the respective companies. For one group, business owners pay more benefits compared to the other.

  3. This debate has been in Sweden in the past. Why don’t change the laws so it easier to be both an employee and an independent contractor?

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