The Difference between Contractor and Employee Status
An individual who performs services for your company could be classified as either an employee or independent contractor. This is an important distinction in the eyes of the IRS, as employers are responsible for collecting and remitting taxes to the government for employees, however, they are not responsible for doing this for independent contractors.
The IRS has specific guidelines to assist a business in determining the status of their workers. These guidelines revolve around how much degree of control and independence the worker has. The three guidelines are Behavioral, Financial, and Type of Relationship. In this article, we will look at each guideline.
Guideline #1: Behavioral
This guideline revolves around the question of whether or not the company controls or has the right to control what the worker does or how the worker does his or her job.
There are four factors that make up this guideline. Each factor can assist you in determining how much control the business has on a worker.
Type of instructions given - If the business determines when, where, and how the work is to be conducted then the worker is generally deemed an employee. According to the IRS, here are examples of “types of instructions” given to a worker that would make them an employee.
- When and where to do the work.
- What tools or equipment to use.
- What workers to hire or to assist with the work.
- Where to purchase supplies and services.
- What work must be performed by a specified individual.
- What order or sequence to follow when performing the work.
Degree of instruction - This factor revolves around how detailed the instructions are. The more detailed the instruction the more control the business has on the worker which would deem the worker as an employee. The less detailed the instructions means that the business has less control which means that the worker could be classified as an independent contractor.
Evaluation systems - If there is an evaluation system in place that measures the details of the work, then the worker is probably considered an employee. If the evaluation just measures the end result then the worker could be an employee or an independent contractor.
Training - This factor measures how much training the business provides to the worker. If the training revolves around how to do the job in a particular way then the worker may be an employee.
The key is to determine how strong the relationship exists of an employer-employee relationship between the worker and the business. The more control in the form of instructions, evaluations, and training would indicate that the relationship is an employer-employee. The less control would indicate that it may be a business-independent contractor relationship.
Guideline #2: Financial
This guideline revolves around how much financial control the business has on the worker. There are five factors that make up this guideline that can assist with determining how much control the business has on the worker.
Significant investment - This factor measures how much of a financial investment a worker made personally in order to do this job. If the worker is required to furnish his or her supplies and equipment to accomplish the job then they may be considered an independent contractor. However, if the business supplies all tools, supplies, and equipment to accomplish the job then the worker may be deemed an employee.
Unreimbursed expenses - If the worker incurs expenses that are not reimbursed by the business then this may indicate that they are independent contractors. If the worker is paid by a fixed amount and they are responsible for procuring supplies to accomplish a job then this would most likely make the worker an independent contractor.
Opportunity for profit and loss - Generally, if a worker could potentially make a profit or incur a loss on a job then they would be considered an independent contractor.
Services available to the market - If the worker has the ability to offer their services to other businesses then they would most likely be deemed an independent contractor.
Method of payment - This factor is based on how the worker is paid. If the worker is paid by a regular wage based on an hourly or weekly rate then the worker is most likely an employee. If the worker is paid a flat fee based on the job then the worker is most likely an independent contractor.
Guideline #3: Type Of Relationship
This guideline revolves around how each party, the worker and the business, would perceive their relationship with each other. There are four factors that would assist in determining this relationship.
Written contracts - The nature of a written contract could point to whether or not the relationship is an employee-employer or an independent contractor-business relationship.
Employee benefits - If the business provides benefits to a worker then the worker may be considered an employee. These benefits could be in the form of insurance, vacation, and paid sick time.
Permanency of the relationship - If the expectation by both parties is that the relationship will continue indefinitely then this could be evidence that the relationship is an employee-employer type. However, if the expectation is that the relationship is just for a specific project or period of time then the relationship could be deemed as an independent contractor-business relationship.
Services provided as key activity of the business - This factor measures how much of a role the workers service provides the business. If the worker has a major role in the operation of the business then the worker would most likely be an employee.
It is important to note that not one guideline stands alone. In other words, all three guidelines must be taken into consideration as a whole. Some guidelines or factors could indicate that the worker is an employee while others would indicate that the person is an independent contractor.
The key is to look at these guidelines through the lens of the IRS by determining how they might classify a worker’s status. The IRS is the agency that has the authority to decide on a status of a worker and if they decide that you misclassified an employee, deliberately or not, then you may be responsible for paying penalties, back pay, back taxes, or other benefits to the worker. It is advisable to seek the advice of an accountant who can help you decide your worker’s status based on your business’s unique situation.