The Employee VS. Independent Contractor Debate
The classification of personnel affects how much a business pays in taxes, if withholding from paychecks is necessary and what tax documents to file. Misclassification of an employee can result in penalties and additional taxes. There are many questions to ask in determining the classification of personnel. There are three main categories the IRS uses in determining the classification. They are listed below in bold:
The first question to ask in determining classification: Does the company control what the worker does and the manner in which he or she does their job? For example, do you set the hours the worker works? Do you set the work location? Do you provide all of the resources and materials? Do you provide training? If you can control what is done and how it is done then your workers are probably employees. If you can control only the outcome of the work and not the method of reaching the outcome then your workers are probably independent contractors. However, there are other factors involved in determining classification.
Can the worker realize a profit or loss? Meaning, does the employer provide the work location and all resources to perform the job. If so, then there is no profit or loss to be realized. If these items are not provided then there is a profit or loss. This will usually mean the worker is classified as an independent contractor. How do you pay the worker? If you pay a flat set fee the worker is probably an independent contractor. If you pay for a period of time, such as hourly or weekly the worker is probably an employee. Does the worker provide services to other businesses? If so, they are probably an independent contractor.
Type of Relationship of the Parties:
What is the underlying nature of the relationship? Sometimes a written contract is necessary to prove this. Does the business provide the worker with benefits, such as insurance or vacation pay? An independent contractor does not receive these type of benefits from an employer. What is the length of time the relationship is expected to last? If it is indefinitely, the worker is most likely an employee. Are the worker’s duties an integral part of the operation? If so, they are probably an employee.
It is important to note, the worker must meet multiple rules before determining their classification.
As a business owner, if you would like to hire an independent contractor it is advisable to find one that is self-employed and pay them through their company. While this alone is not enough to determine classification it can help prove the nature of the relationship.
An example of an employee
You own a music studio and you hire Joe to come into the office Monday thru Friday to answer the phones and other administrative tasks. While you are a bit flexible with the hours, you do need him to be present during your core hours of 9-4. Without his presence in your studio there would be no one to perform these tasks, which makes him an integral part of your operation. You pay him hourly and provide vacation and sick time. You provide training on how he should perform the work required. When Joe was hired there was no length of time agreed upon for his employment.
Joe is an employee for many reasons. The employer controls where Joe works, what he does, how he performs his job and all of the resources needed. He is paid hourly and is provided benefits. His length of employment is indefinite. Joe is the only office employee and is an integral part of the business.
Because Joe is an employee of the company the employer does withdraw various taxes from his paycheck.
An example of an independent contractor
As your music studio grows you decide you no longer have time to perform the bookkeeping duties. You hire Annie to take over these duties. You provide Annie with the bookkeeping documents but she provides all other resources needed to perform the job. She works from her office and has several other clients. She works on your account for an average of 10 hours a week. Monthly she sends you an itemized bill of the services provided and the individual rates. You do not provide her insurance, sick pay or any other type of benefits. You do not provide any type of training for Annie. While you did not set a specific end date for the job you did sign a contract, provided by Annie, that allows for termination of services after 30 days.
Annie meets many of the requirements of an independent contractor. The employer does not have control over where Annie works, how she performs her job and does not provide or control the resources needed to perform the job. She is paid monthly based on an itemized invoice and she performs work for other clients. She is not provided any type of benefits or training. Because Annie controls her work environment and resources needed she can suffer a profit or loss in the business transaction.
Because Annie is an independent contractor the employer does not deduct taxes from the paycheck.
While these examples might seem pretty straightforward there are plenty more that are more complex. Keep in mind, the employee must meet multiple criteria before proper classification can be determined. You can read more on classification here on the IRS site.
Copyright 2014 Christi Rains, Alpha Omega Consulting & Bookkeeping, LLC