On the crucial question of whether a worker is an employee or an independent contractor, you had better answer correctly. Otherwise, expect scrutiny from the IRS, which monitors worker status to make sure Uncle Sam collects all taxes due.
Conferring contractor status on a worker benefits the employer, which then doesn’t have to withhold income tax or pay Social Security and unemployment taxes.
The IRS looks at three broad categories of information to decide whether someone is an employee or a contractor. You can use them, too, to make sure you are in compliance with the law.
1. Behavioral control
Behavioral control focuses on whether the business has the right to direct or control how the work is done—e.g., how the worker performs the specific task for which he was hired. Factors include:
- To what extent are instructions given and taken? An employee is generally subject to the business’s instructions about when, where and how to work. An independent contractor is not.
- Does the business provide training to the worker? Employees may be trained to perform services in a particular manner. Independent contractors ordinarily use their own methods.
2. Financial control
These factors illustrate the degree of control over the business aspects of the worker’s activities:
- Can the worker realize a profit or incur a loss? A contractor can make a profit or suffer a loss. An employee can only earn money, not lose it.
- Is the worker’s investment significant? An independent contractor often has a significant investment in the equipment or facilities used to perform services for someone else. Employees typically use tools and equipment provided by their employers.
- To what extent does the worker make services available to the general public? Does the worker market, with the goal of working for more than one firm?
- How does the business pay the worker? An employee is generally paid by the hour, week or month. An independent contractor is generally paid a flat fee or by the job.
3. Relationship between parties
These factors illustrate how the worker and the business perceive their relationship:
- Does a written contract describe the relationship between the parties? Simply having a worker sign a contract doesn’t make that person an independent contractor. The substance of the agreement—not a label such as “contract for services”—governs the worker’s status.
- Does the business provide the worker with benefits, such as insurance, a pension, vacation pay or sick pay? are paid only to employees.
- How permanent and ongoing is this relationship? Permanent and indefinite relationships indicate an employer-employee relationship.
- To what extent are the services performed by the worker a key aspect of the regular business of the company? Is the success of the business dependent, to an appreciable degree, upon the worker’s performance? If so, an employer-employee relationship exists. For example, restaurants need cooks and cashiers, so those workers are generally employees. But, although an appliance store needs good accountants, bookkeeping is not the store’s regular business. Therefore, that work can be done equally well by either an independent contractor or an employee.
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