Employee vs. Independent Contractor
Who is an employee?
An employer must decide if each worker receiving payments for services performed is an employee or a nonemployee (also known as an independent contractor).
- Payments to employees require employers to withhold taxes (income, Social Security and Medicare) and report wages subject to taxation (through Forms 941 and W-2). Employers are also responsible for employment taxes (i.e., unemployment, Social Security and Medicare).
- Payments to independent contractors may require employers to withhold taxes (backup withholding) and report payments (Form 1099-Misc), depending on their status.
Identifying an Employee
Generally, workers who perform services are employees if the employer controls what will be done and how it will be done. The employee may have great latitude in the process, but if the employer controls what the tasks are and how the tasks are completed, generally the worker is an employee. The key factor is whether the employer has the legal right to control the methods and results of the work to be done.
An individual is an employee when he or she:
1. Maintains a continuous relationship with an employer;
2. Is subject to the control of the employer, even when the employer chooses not to exercise the control;
3. Performs work personally, receiving training, tools, equipment or supplies from the employer;
4. Works hours and locations assigned by the employer; and
5. Qualifies for the company’s benefit plans.
Designating a worker’s status as an employee or independent contractor is the responsibility of the employer, not the worker. An attorney or CPA will be able to help the business owner to determine a worker’s classification. However, the guidelines set forth by the common law test should assist most employers in deciding their workers’ proper classification. If the employer finds that additional help is necessary in this process, the IRS has also created a procedure for determining worker classification through Form SS-8.
Common Law Test
Under common law rules developed over many years of court decisions, every individual who performs services subject to the will and control of an employer, as to both what must be done and how it must be done, is an employee. It does not matter that the employer has the legal right to control both the method and result of the services. Two usual characteristics of an employer-employee relationship are that the employer has the right to discharge the employee and the employer supplies the employee with tools and a place to work.
The common law test determines whether the employer controls the actions of the employee. When applying the common law test, seven questions are asked:
1. Who controls the work?
2. What work will be done?
3. How will the work be done?
4. Who supplies the tools and equipment required to complete the work?
5. When will the work be done?
6. Where will the work be done?
7. Does the worker have the ability to make a profit or suffer a loss?
The IRS has established a testing procedure to make the classification of workers easier for employers. Testing is accomplished by completing Form SS-8, Determination of Employee Work Status for Purposes of Federal Employment Taxes and Income Tax Withholding. Employers answer the 20 questions on the SS-8 and submit a copy to the IRS.
While awaiting the IRS’ response to the SS-8, the employer must treat the worker as an employee. During this time, the worker must have the appropriate taxes withheld and reported. The taxes will not be refunded to the worker or the employer if the worker is found to be an independent contractor and not an employee.
The following table compares and contrasts employees and independent contractors under the common law test. Remember, the crucial distinction is the employer’s right to control the worker.
The material contained in this document is for informational purposes only and is current as of the date of publication. CompuPay is not a legal advisor or financial advisor and makes no claims as such. For financial or legal advice, please seek the advice of a professional.