04/ 12/ 2007
by Jeffrey Moses
One of the thorniest problems employers handle is accurately making the distinction between independent contractors and employees. While the difference may be clear in your own mind, the Internal Revenue Service applies complex criteria to the question, so you should be certain that your independent contractors meet the IRS's test before treating them as contractors. Above all, seek outside legal advice when making the initial decision and throughout the employment/contractor relationship when circumstances change.
Aggravated by the hassle? NFIB has long sought to simplify the test to identify independent contractors, so let your lawmakers know that the IRS' current complex test creates extra paperwork and expense for your business.
What's the difference to you?
There is often a thin line between who is as an employee and who is an independent contractor. This distinction can be significant for employers because companies are normally required to provide employees' federal and local withholding taxes, withhold and pay Social Security and Medicare taxes, provide all tax documentation and pay workers' compensation. Companies are exempt from providing these for workers determined to be independent contractors. When a company is determined to have not provided withholding and documentation for workers that the IRS deems to be employees, penalties can be charged.
How do you know?
The distinction between employee and independent contractor usually is determined by the amount of control the company has over the way in which the individual works and by the support given to an individual.
For instance, when a person works at the company's facility (i.e., is provided a desk or a specific work locale within the facility), is supplied with required equipment (computer, phone, fax, production machinery, etc.), is not required to pay for the facility's phone and utility bills, and has specific, required hours of work, the person would normally be considered an employee.
When a person works outside the company's facility, pays for and uses his or her own equipment, pays his or her own insurance, phone and utility bills and is not required to work specific hours (even though deadlines for completion of work may exist), the person would normally be considered an independent contractor.
In our telecommuting age, however, these distinctions may blur. For instance, a telecommuting employee who works from home (perhaps even in another state from which the company's facility is located) may not have specific, required hours, may pay his or her own phone and utility bills and may not even use equipment provided by the company.
The determinations that make this person an employee are the length of employment, the way in which the person is supervised (whether supervisors and peers are all salaried employees of the company, for example) and the degree to which the company determines the person's work schedule.
Also significant in a determination would be whether the individual can turn down work offered by the company (if no, the person is likely an employee), whether the company provides training that is required (if yes, the person is likely an employee), and whether the individual is performing the same type of work for other companies while working at a location outside the company's facility (if yes, the person is likely an independent contractor). Also of key importance is whether the worker contracts out to more than one company at a time.
Many independent contractors work for a number of companies simultaneously, bill each company for hours or work completed and pay their own insurance, utilities and other working costs (although these may be reimbursed by each company). Most independent contractors file either a Schedule C for their 1040 Form when paying federal taxes (Profit or Loss From Business--Sole Proprietorship) or a Form 1065 (Return of Partnership Income) if they are in a partnership.
Any worker who is directly involved in the profit and loss of a company, whether working from home or at the company's facility, would be deemed to be an employee of the company.
Details from the IRS
As a final note: the IRS Web site says: "A general rule is that you, the payer, have the right to control or direct only the result of the work done by an independent contractor, and not the means and methods of accomplishing the result." The site goes on to state: "A general rule is that anyone who performs services for you is your employee if you can control what will be done and how it will be done."
The site provides numerous examples to clarify the distinctions between employee status and independent contractor status.
In conclusion, the site says: "To determine whether an individual is an employee or independent contractor under the common law, the relationship of the worker and the business must be examined. All evidence of control and independence must be considered. In an employee-independent contractor determination, all information that provides evidence of the degree of control and degree of independence must be considered."
