The distinction between an employee and a contractor becomes very important when it comes time to file taxes. How can you tell if the person working for you is an employee or a contractor?
The IRS publishes a guide to help you distinguish between employees and contractors. The rules aren’t hard-and-fast, though. The IRS breaks the worker’s characteristics into three categories. Taken together, these characteristics determine the worker’s tax status.
1. Behavioral Control
This is the first of the IRS’ three categories. Does the employer have the right to control what the worker does? What type, and how much, instruction does the employer give the worker? Is continual training provided? Does an ongoing evaluation system exist?
What does this look like? The employer decides:
- When and where the worker should perform the task
- What tools or equipment the worker uses
- What workers to hire
The employer will often give this type of instruction to employees. Contractors do not usually receive these instructions.
Some employees, especially those with high position/experience, may not need detailed instructions. These employees also may not need ongoing training. The IRS may still classify these workers as employees.
If an evaluation system measures the end product only, the worker might be a contractor. If the evaluation system measure the process and product, the worker might be an employee.
2. Financial Control
According to the IRS, an independent contractor has control over financial concerns. These include: significant investment, unreimbursed expenses, profit and loss opportunities, services available to the market, and method of payment. In summary, the contractor takes responsibility for financial decisions. The level of financial control does not have a dollar amount.
An employee generally receives a regular wage. Employees are often paid by amount of hours worked. An employee’s’ salary is rarely the “flat fee” for a job that a contractor might receive.
3. Type of Relationship
What benefits does the employer offer the worker?
Paid vacation and insurance generally indicated that a worker is an employee. However, the lack of employee benefits does not mean the worker cannot be a employee.
Is the employer-worker relationship on-going?
A worker hired without an end-date generally has an employer-employee relationship.
What types of tasks does the worker perform?
A worker hired to perform business operation tasks are generally employees.
Together, these elements describe the type of relationship between the employer and worker. A written contract does not necessarily determine the relationship. In some cases, a contract listing a worker as an employee may not actually decide the worker’s status. The IRS may decide the worker is actually a contractor, based on the factors described in this post.
The employee vs. contractor guidelines can be complicated. You should use the guidelines to the best of your ability. Be aware that each of the categories may be open to interpretation by the IRS. You can be liable for employment taxes of an employee if you incorrectly name him/her a contractor. To check the worker’s status, you can file IRS form SS-8.
Tax1099.com offers 1099 for contractors, and W-2 forms for employees. Visit Tax1099.com to get started.
