Employers have several tax obligations related to their employees. They are expected to withhold income taxes and social security and Medicare taxes from their employees’ pay in addition to paying unemployment tax on their wages. Conversely, employers have no tax obligations on payments they make to true independent contractors. Knowing the difference between employees and independent contractors is an ongoing point of debate within the IRS, but let’s review the key indicators of each here.
The IRS defines employees, also known as ‘common-law employees’ as those workers employed by a business, performing services on either a seasonal or permanent basis. As an employer, you have the right to control, how, when, where and with what equipment the employees perform those services.
In contrast, an independent contractor performs services for a business, but does so with much more personal discretion as to when, where, and with what equipment that service is completed.
There are generally three common law categories that can be used to help you distinguish the type of business relationship you have with your worker and whether or not he or she is an independent contractor or an employee. They are behavioral, financial, and type of relationship – and they highlight the levels of control and independence in the business relationship.
Behavioral – Consider whether you have the right to control what your worker does and how he or she gets the job done.
Financial – Do you control all the business aspects of the job, such as supplying tools and materials, or deciding how the worker is paid, and whether or not expenses are reimbursed.
Type of relationship – Are there written contracts or benefits established, such as a pension plan, leave pay, or insurance? Is it an ongoing relationship that facilitates a key service to the business?
Erroneously mislabeling an employee as an independent contractor can cost you. For example, if workers are deemed to be employees by the IRS rather than independent contractors, you may have to reimburse them for any wages and overtime owed, or pay owed taxes and tax penalties for income, Social Security, Medicare and unemployment taxes. Your errors may also be subject to legal consequences.
With the many different kinds of trades, services, and business arrangements available across the many industries in our market, there are some workers who just do not seem to fit perfectly into any one category of either employee or independent contractor.
To complicate the matter even further, certain kinds of independent contractors may also be considered statutory employees for tax purposes. An example of this kind of service provider is a life insurance sales agent who works full-time and who chooses to sell life insurance or annuity contracts for one particular life insurance company. In the same vein, certain workers may be considered statutory non-employees.
While the IRS provides extensive guidance on determining a worker’s status, there is no strict black and white, easy-delineation; you are encouraged to look at the entire business relationship to come to an understanding. If after you have looked into the situation thoroughly and you still have doubts, you can get help from the IRS by filing Form SS-8, Determination of Worker Status for Purposes of Federal Employment Taxes and Income Tax Withholding. The IRS will look over the data and officially identify the worker’s status for you.
A small business accountant can provide insight and assets in the financial and tax areas of managing employees and/or contractors for your business. He or she can help you break down the various federal and local tax laws to ensure that you file properly.
To find a PASBA small business professional in your areas, click on the PASBA directory of small business accountants under the ‘Find an Accountant’ link on this page. They are listed by state or city, such as “Florida Accountants,” “Georgia Accountants” or “Granite Bay Accountants.”
PASBA member accountants bring the collective resources of a nationwide network of Certified Public Accountants, Public Accountants, Enrolled Agents and other practitioners available to answer your tax and financial questions and streamline your business accounting, bookkeeping, and payroll operations. To find a trusted accountant in your area, visit www.SmallBizAccountants.com.
Please be advised that, based on current IRS rules and standards, any advice contained herein is not intended to be used, nor can it be used, for the avoidance of any tax penalty that the IRS may assess related to this matter. Any information contained in this article, whether viewed or subsequently printed, cannot be relied upon as qualified tax and accounting advice. Any information contained in this article does not fall under the guidelines of IRS Circular 230.
Copyright 2013 Professional Association of Small Business Accountants