January 08, 2018
As a business owner, there are several questions you must ask. Do you have a retirement or transition plan? How will you reach your strategic goals? Do you have employees? Are you really sure they are employees?
Yes, this is a question you need to verify in your organization. Do you really have employees? Or are they independent contractors? The business relationship between the organization (you) and the person performing the services is an incredibly important one to define. Only once these roles are defined will you know how payments should be treated.
Four types of workers
There are four ways the person who performs the services for your organization can be classified: common law employee, statutory employee, statutory non-employee or an independent contractor.
Common law employee
The key to common-law rules is control. If the organization can control what will be done (the results of the work) and how it will be done (the method by which the work is performed), then the person performing the services is the organization’s employee.
It doesn’t matter under common-law rules what your title is or how your workers are classified. Managers, support staff, supervisory personnel … they’re all employees. Partners, however, are not employees.
Common-law employees are not the only type of employees. Independent contractors can still be considered employees by statute if they fall under any of the following four categories:
These individuals fall into three categories: direct sellers, licenses real estate agents and certain companion sitters.
An individual who provides services to another individual or business. This individual is a separate business entity doing work on behalf of an organization.
So how do I tell which I have?
An employer-employee relationship is most often determined by the “common-law” test. As noted above, the common-law test focuses on control, specifically related to two elements:
An individual is considered an employee if the employer can control both aspects of the test. In other words, you have the right to control the results of the work and how the work is performed.
A worker is considered an independent contractor if the employer can only control the result of the work. Simply put, if the individual can dictate how the work is performed, that person is considered an independent contractor.
Why does this matter?
If an individual is considered an employee, you as the business owner are required to withhold payroll tax. If they’re an independent contractor, you’re not. And when it comes to year-end planning/tax time, employees receive Form W-2, while independent contractors receive Form 1099-MISC.
Anything else I need to know?
An important distinction for independent contractors is that they are, in fact, independent. But how do you really define independence versus control? The IRS uses three categories to help determine employee status:
Here we’re talking about the right to direct or control how the worker performs a specific task. Specifically, this category looks at types of instruction given (what tools to use, what workers to hire, when the work is to be performed, etc.), if there’s an evaluation system to measure details of performance and if ongoing training is given.
If these items are all present, it generally points toward an employee/employer relationship.
When looking at financial control, the IRS looks at factors that point to control of the economic aspects of a worker’s activities. Things to consider include:
If the answers to the above questions are yes, then you’re looking at an independent contractor relationship. Other items to note in this category include method of payment (hourly v. flat fee for services) and opportunity for profit or loss (is the individual free to make business decisions affecting his/her own profit or loss).
Relationship of Parties
This category hinges on the question of how the worker and the business perceive each other in terms of intent concerning control.
What does intent concerning control mean? Here are some triggers:
Still not sure?
No set of factors will give you a definite answer. When the IRS looks at who is an employee and who isn’t, they look at all the facts and circumstances within that particular situation.
If you find yourself second guessing if an individual is an employee or and independent contractor, there’s a special form known as Form SS-8. The IRS uses the information on that form, as well as any other information they can obtain from the parties involved, to determine the status of the worker in question.
Want to learn more?
There’s lots more on this topic, as well as the forms that go with each type of individual, available in our W2/1099 Year End Planning book. Check it out.