Employee vs Independent Contractor – Who’s Who?
How do I determine whether a worker is an employee or an independent contractor? The easiest way to answer this question is, do I have control over that individual? If the answer is yes, then they should most likely be considered an employee. If the answer is no, then they should most likely be considered an independent contractor.
The IRS has compiled a “20 Factor Test” to help determine whether a worker is an employee or an independent contractor. The most important factors are in bold.
- Instructions to worker – If the employer has the right to control and direct the worker regarding the detail and means by which a task is achieved, the worker is generally considered an employee.
- Training
- Integration into business operations
- Requirement that services be rendered personally
- Hiring, supervising, and paying assistants
- Continuity of the relationship (permanency)
- Setting the hours of work
- Requirement of full-time work
- Working on employer premises
- Setting the order or sequence of work
- Requiring oral or written reports
- Paying worker by the hour, week, or month
- Payment of worker’s business and/or travel expenses
- Furnishing worker’s tools and materials – If the business furnishes sufficient tools, materials, and other equipment to complete tasks, then it’s generally considered an employee-employer relationship.
- Significant investment by worker
- Realization of profit or loss by worker
- Working for more than one business at a time – If the worker performs services for a number of unrelated businesses at the same time, the worker is generally considered an independent contractor.
- Availability of worker’s services to the general public
- Firm’s right to discharge work
- Worker’s right to terminate relationship
Let’s use an example to help understand the differences. Ted mows lawns and pulls weeds for XYZ once a week from May through October. He provides his own lawnmower and can perform these tasks at any time as long as it’s once a week. Ted also does this for five other businesses in town. He does his billing and scheduling from his own home office. Should Ted be considered an employee or independent contractor? He is an independent contractor. Why? In the grand scheme of things, he has control over what he does. XYZ hired him to do a specific task, but he has the authority to choose when and how that task is completed.
If on the other hand, Ted worked for a company that owned several apartments, mowed for them 4 days a week, used the company’s vehicles and mowers, and was paid an hourly wage – he undoubtedly is an employee.
The next big question, why does it matter? If the worker is considered an independent contractor the amounts paid to that individual are not subject to federal income tax withholding, but the independent contractor may have to pay self-employment tax. Also, if you pay the independent contractor $600 or more for services performed then the business will need to issue a form 1099 to that independent contractor for the year.
The biggest risk to an employer is to incorrectly treat a worker as a contractor, when in fact they are an employee. The employer could be subject to federal employment taxes, penalties, and interest. Also, federal and state unemployment taxes and worker compensation insurance. To add to the misery, the penalties and interest might amount to more than the actual tax.
All in all, determining whether a worker is an employee, or an independent contractor is a little tricky and convoluted. Please reach out to your tax professional at KTLLP if you have questions or want to discuss in more detail the differences between an employee and an independent contractor.