As a business owner, it is imperative that one understands the difference between an independent contractor versus an employee because intentionally or carelessly misclassifying a worker can sometimes result in significant financial consequences for a business and if you are a small business or any business for that matter this can often times be financially devastating depending on the quantity of misclassified employees. So, in order to ensure you are correctly designating your employees within the legal requirements of the IRS and Department of Labor, you will need to understand how to differentiate the two.
So What Exactly Is an Employee and How Is That Different From an Independent Contractor?
An employee, to put it in simply, is someone whom an employer has CONTROL over. The IRS specifically breaks it down into three categories.
A. Behavioral Control: Here you want to look at the autonomy/control that the worker has to do their job. Are they directed primarily by the employer in the tasks and how their tasks are performed? If the answer is yes, then they would be classified as an employee. If they control their own schedule and how they perform their work, then the answer is no. If you are a small business owner who hires virtual assistants for instance, this is an important one for you to think about in considering who has control, as this type of work usually has blurry lines.
B. Financial Control: Here you want to consider the level of reimbursed or unreimbursed business expenses that the worker has accrued doing the work and the level of their financial investment in the job. What are the tools they are using for the job and who is providing them? Are you providing them the tools or are they paying for and providing their own? If they answer is the latter, there is some evidence that shows they are independent contractors.
C. Type of Relationship: The relationship between the worker and the employer determines this final category. Are there written contracts that describe the relationship that both parties intended to enter? What sort of benefit is the employee offering the worker if any? An employer would typically provide benefits such as health insurance, sick leave, vacation and 401k to an employee and would generally not offer that to an independent contractor. Ultimately, if you determine that your worker falls under the description of an independent contractor, as an employer, you are not responsible for benefits, social security, unemployment tax nor are you responsible for providing all payroll reports to the worker.
A caveat: If your independent contractor made more than $600 from you, you will need to issue a 1099 at the end of that tax year.
Finally, as a business owner, if you are considering classifying a worker as an independent contractor, you must show there is a reasonable basis for that classification to escape the financial penalty of misclassification.
If you need more help in determining the right classification type for your worker, the IRS provides Form SS-8, Determination of Worker Status for Purposes of Federal Employment Taxes and Income Tax Withholding (PDF). The great thing about this form is either your company or worker can complete it and send it to the IRS for review. Once this has been reviewed by the IRS, you will be sent back a response with a determination the proper classification for your worker.
Ayesha Chidolue is the Managing Attorney at The Chidolue Law Firm, we are a boutique law firm that specializes in small business law. Attorney Chidolue is licensed to practice law in the states of Florida and New York. If you need legal assistance with your business, we will be happy to assist you. Please contact us at firstname.lastname@example.org or call us at 407-995-6567