Employee or Independent Contractor
(What is the Difference)?
An employer must generally withhold income taxes, withhold and pay
social security and Medicare taxes, and pay unemployment taxes on wages
paid to an employee. An employer does not generally have to withhold
or pay any taxes on payments to independent contractors.
Common-law Rules
To determine whether an individual is an employee or an 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 any employee/independent contractor determination,
all information that provides evidence of the degree of control and
the degree of independence must be considered.
Facts that provide evidence of the degree of control and independence
fall into three categories: behavioral control, financial control, and
the type of relationship of the parties.
Behavioral Control
Facts that show whether the business has a right to direct and control
how the worker does the task for which the worker is hired include the
type and degree of:
- Instructions the business gives the worker.
- An employee is generally subject to the business' instructions
about when, where, and how to work. Even if no instructions are
given, sufficient behavioral control may exist if the employer
has the right to control how the work results are achieved.
- Training the business gives the worker.
- An employee may be trained to perform services in a particular
manner. Independent contractors ordinarily use their own methods.
Financial Control
Facts that show whether the business has a right to control the business
aspects of the worker's job include:
- The extent to which the worker has unreimbursed business expenses.
Independent contractors are more likely to have unreimbursed expenses
than employees. Fixed ongoing costs that are incurred regardless of
whether work is currently being performed are especially important.
However, employees may also incur unreimbursed expenses in connection
with the services they perform for their business.
- The extent of the worker's investment. An independent contractor
often has a significant investment in the facilities he or she uses
in performing services for someone else. However, a significant investment
is not required.
- The extent to which the worker makes services available to the
relevant market.
- How the business pays the worker. An employee is generally paid
by the hour, week, or month. An independent contractor is usually
paid by the job. However, it is common in some professions, such as
law, to pay independent contractors hourly.
- The extent to which the worker can realize a profit or incur a loss.
An independent contractor can make a profit or loss.
Type of Relationship
Facts that show the party's type of relationship include:
- Written contracts describing the relationship the parties intended
to create.
- Whether the business provides the worker with employee-type benefits,
such as insurance, a pension plan, vacation pay, or sick pay.
- The permanency of the relationship. If you engage a worker with
the expectation that the relationship will continue indefinitely,
rather than for a specific project or period, this is generally considered
evidence that your intent was to create an employer-employee relationship.
- The extent to which services performed by the worker are a key
aspect of the regular business of the company. If a worker provides
services that are a key aspect of your regular business activity,
it is more likely that you will have the right to direct and control
his or her activities. For example, if a law firm hires an attorney,
it is likely that it will present the attorney's work as its own and
would have the right to control or direct that work. This would indicate
an employer-employee relationship.
IRS Help
If you want the IRS to determine whether a worker is an employee,
file Form SS-8: Determination of Employee Work Status for Purposes of
Federal Employment Taxes and Income Tax Withholding, with the IRS.
Industry Examples
The following examples may help you properly classify your workers.
Building and Construction Industry Example
Example 1.
Jerry Jones has an agreement with Wilma White to supervise the remodeling
of her house. She did not advance funds to help him carry on the work.
She makes direct payments to the suppliers for all necessary materials.
She carries liability and workers' compensation insurance covering Jerry
and others he engaged to assist him. She pays them an hourly rate and
exercises almost constant supervision over the work. Jerry is not free
to transfer his assistants to other jobs. He may not work on other jobs
while working for Wilma. He assumes no responsibility to complete the
work and will incur no contractual liability if he fails to do so. He
and his assistants perform personal services for hourly wages. They
are employees of Wilma White.
Example 2.
Milton Manning, an experienced tilesetter, orally agreed with a corporation
to perform full-time services at construction sites. He uses his own
tools and performs services in the order designated by the corporation
and according to its specifications. The corporation supplies all materials,
makes frequent inspections of his work, pays him on a piecework basis,
and carries workers' compensation insurance on him. He does not have
a place of business or hold himself out to perform similar services
for others. Either party can end the services at any time. Milton Manning
is an employee of the corporation.
Example 3.
Wallace Black agreed with the Sawdust Co. to supply the construction
labor for a group of houses. The company agreed to pay all construction
costs. However, he supplies all the tools and equipment. He performs
personal services as a carpenter and mechanic for an hourly wage. He
also acts as superintendent and foreman and engages other individuals
to assist him. The company has the right to select, approve, or discharge
any helper. A company representative makes frequent inspections of the
construction site. When a house is finished, Wallace is paid a certain
percentage of its costs. He is not responsible for faults, defects of
construction, or wasteful operation. At the end of each week, he presents
the company with a statement of the amount he has spent, including the
payroll. The company gives him a check for that amount from which he
pays the assistants, although he is not personally liable for their
wages. Wallace Black and his assistants are employees of the Sawdust
Co.
Example 4.
Bill Plum contracted with Elm Corporation to complete the roofing on
a housing complex. A signed contract established a flat amount for the
services rendered by Bill Plum. Bill is a licensed roofer and carries
workers' compensation and liability insurance under the business name,
Plum Roofing. He hires his own roofers who are treated as employees
for Federal employment tax purposes. If there is a problem with the
roofing work, Plum Roofing is responsible for paying for any repairs.
Bill Plum, doing business as Plum Roofing, is an independent contractor.
Example 5.
Vera Elm, an electrician, submitted a job estimate to a housing complex
for electrical work at $16 per hour for 400 hours. She is to receive
$1,280 every 2 weeks for the next 10 weeks. This is not considered payment
by the hour. Even if she works more or less than 400 hours to complete
the work, Vera Elm will receive $6,400. She also performs additional
electrical installations under contracts with other companies, which
she obtained through advertisements. Vera is an independent contractor.
Trucking Industry Example
Rose Trucking contracts to deliver material for Forest Inc. at $140
per ton. Rose Trucking is not paid for any articles that are not delivered.
At times, Jan Rose, who operates as Rose Trucking, may also lease another
truck and engage a driver to complete the contract. All operating expenses,
including insurance coverage, are paid by Jan Rose. All equipment is
owned or rented by Jan, and she is responsible for all maintenance.
None of the drivers are provided by Forest Inc. Jan Rose, operating
as Rose Trucking, is an independent contractor.
Computer Industry Example
Steve Smith, a computer programmer, is laid off when Megabyte, Inc.
downsizes. Megabyte agrees to pay Steve a flat amount to complete a
one-time project to create a certain product. It is not clear how long
it will take to complete the project, and Steve is not guaranteed any
minimum payment for the hours spent on the program. Megabyte provides
Steve with no instructions beyond the specifications for the product
itself. Steve and Megabyte have a written contract, which provides that
Steve is considered to be an independent contractor, is required to
pay Federal and state taxes, and receives no benefits from Megabyte.
Megabyte will file a Form 1099-MISC. Steve does the work on a new high-end
computer, which cost him $7,000. Steve works at home and is not expected
or allowed to attend meetings of the software development group. Steve
is an independent contractor.
Automobile Industry Example
Example 1.
Donna Lee is a salesperson employed on a full-time basis by Bob Blue,
an auto dealer. She works 6 days a week and is on duty in Bob's showroom
on certain assigned days and times. She appraises trade-ins, but her
appraisals are subject to the sales manager's approval. Lists of prospective
customers belong to the dealer. She has to develop leads and report
results to the sales manager. Because of her experience, she requires
only minimal assistance in closing and financing sales and in other
phases of her work. She is paid a commission and is eligible for prizes
and bonuses offered by Bob. Bob also pays the cost of health insurance
and group-term life insurance for Donna. Donna is an employee of Bob
Blue.
Example 2.
Sam Sparks performs auto repair services in the repair department
of an auto sales company. He works regular hours and is paid on a percentage
basis. He has no investment in the repair department. The sales company
supplies all facilities, repair parts, and supplies; issues instructions
on the amounts to be charged, parts to be used, and the time for completion
of each job; and checks all estimates and repair orders. Sam is an employee
of the sales company.
Example 3.
An auto sales agency furnishes space for Helen Smith to perform auto
repair services. She provides her own tools, equipment, and supplies.
She seeks out business from insurance adjusters and other individuals
and does all the body and paint work that comes to the agency. She hires
and discharges her own helpers, determines her own and her helpers'
working hours, quotes prices for repair work, makes all necessary adjustments,
assumes all losses from uncollectible accounts, and receives, as compensation
for her services, a large percentage of the gross collections from the
auto repair shop. Helen is an independent contractor and the helpers
are her employees.
Attorney Example
Donna Yuma is a sole practitioner who rents office space and pays
for the following items: telephone, computer, on-line legal research
linkup, fax machine, and photocopier. Donna buys office supplies and
pays bar dues and membership dues for three other professional organizations.
Donna has a part-time receptionist who also does the bookkeeping. She
pays the receptionist, withholds and pays Federal and state employment
taxes, and files a Form W-2 each year. For the past 2 years, Donna has
had only three clients, corporations with which there have been long-standing
relationships. Donna charges the corporations an hourly rate for her
services, sending monthly bills detailing the work performed for the
prior month. The bills include charges for long distance calls, on-line
research time, fax charges, photocopies, mailing costs, and travel,
costs for which the corporations have agreed to reimburse. Donna is
an independent contractor.
Taxicab Driver Example
Tom Spruce rents a cab from Taft Cab Co. for $150 per day. He pays
the costs of maintaining and operating the cab. Tom Spruce keeps all
fares he receives from customers. Although he receives the benefit of
Taft's two-way radio communication equipment, dispatcher, and advertising,
these items benefit both Taft and Tom Spruce. Tom Spruce is an independent
contractor.
Salesperson
To determine whether salespersons are employees under the usual common-law
rules, you must evaluate each individual case. If a salesperson who
works for you does not meet the tests for a common-law employee, discussed
earlier, you do not have to withhold income tax from his or her pay
(see Statutory Employees earlier). However, even if a salesperson is
not an employee under the usual common-law rules, his or her pay may
still be subject to social security, Medicare, and FUTA taxes. To determine
whether a salesperson is an employee for social security, Medicare,
and FUTA tax purposes, the salesperson must meet all eight elements
of the statutory employee test. A salesperson is an employee for social
security, Medicare, and FUTA tax purposes if he or she:
- works full time for one person or company except, possibly, for
sideline sales activities on behalf of some other person,
- sells on behalf of, and turns his or her orders over to, the person
or company for which he or she works,
- sells to wholesalers, retailers, contractors, or operators of hotels,
restaurants, or similar establishments,
- sells merchandise for resale, or supplies for use in the customer's
business,
- agrees to do substantially all of this work personally,
- has no substantial investment in the facilities used to do the work,
other than in facilities for transportation?
- maintains a continuing relationship with the person or company for
which he or she works, and
- is not an employee under common-law rules.
For further assistance and information, visit the Small
Business Tax Resource Guide.
Authored by: Missouri Small Business Development
Centers
Source: IRS information
Date Reviewed: 7/3/07
