Insights: Article

Independent Contractor or Employee?

By   Angie Ziegler

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.

Statutory employee

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:

  1. A driver who distributes beverages (other than milk) or food (meat, vegetable, fruit or bakery products) or who delivers dry cleaning if the driver is the organization’s agent or paid on commission.
  2. A full-time life insurance sales agent who sells primarily for one life insurance company.
  3. Someone who works at home on materials for an organization. The organization supplies the materials and materials must be returned to the organization if the organization furnishes specifics for the work to be done.
  4. A full-time salesperson who works on behalf of an organization with wholesalers, retailers, contractors or hotel operators, etc. as their primary business activity.

Statutory non-employee

These individuals fall into three categories: direct sellers, licenses real estate agents and certain companion sitters.

Independent contractor

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:

  1. What must be done (the results of the work)
  2. How it must be done (the way the work is performed)

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: 

Behavioral control

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.

Financial control

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:

  • Significant investment: Has the individual made a significant investment in tools or facilities used to perform the task for your organization?
  • Unreimbursed expenses: Has the individual chosen to incur expenses and bear the cost of the services provided for your organization?
  • Services available to relevant market: Does the individual make themselves available to other organizations or individuals similar to your organization?

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:

  • Intent of parties/written contracts: a written agreement describing the worker as an independent contractor, methods of payment, expenses to be reimbursed, etc
  • Employee benefits: providing a worker with benefits including paid vacation or sick pay, health insurance, life insurance, etc.
  • Regular business activity: services performed by the individual are a key aspect of the regular business of the organization

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. 

Latest Insights

July 19, 2018
While it’s great to watch your team grow, hiring new employees can be a frustrating and grueling process.
July 19, 2018
Often, human resources (HR) is over looked, but we’re here to tell you it’s an essential component of any organization and critically important to get right.
July 13, 2018
Here are some idea for giving your new hire a smooth start into your business and alleviating stress for you.
July 13, 2018
The impact of the recent SCOTUS Wayfair decision will continue to have a ripple effect on businesses and state sales tax compliance.
July 9, 2018
The revenue cycle is a complex system and we have historically given much attention to the front-end and back-end while oftentimes leaving the middle functions of the cycle neglected.
July 3, 2018
FASB Accounting Standards Codification Topic 606, Revenue from Contracts with Customers, provides a 5-step framework for determining revenue recognition.
July 2, 2018
As part of the Tax Reform Act of 1986, the “Kiddie tax,” a taxing regime designed to make the transfer of income items by wealthy parents to lower tax paying children less attractive, was implemented.
July 2, 2018
When it comes to your employees, you likely conducted interviews on them when you first hired them.
July 2, 2018
Nearly ten years after the release of the initial exposure draft, FASB issued ASU 2016-02, Leases - The standard may have been issued, but the conversation about this re-write of legacy guidance has not slowed.