Independent Contractor or Employee: How Do You Know?

Last week we discussed how important it is for a business owner to be classifying their workers appropriately or risk increased penalties from the IRS. But how do you know how the IRS classifies an individual working for you? How can a business owner determine the business relationship between themselves and an individual, and how do they classify them as an independent contractor, an employee, a statutory employee or statutory nonemployee?

Let’s get the last two out of the way: A statutory employee is a certain type of independent contractor that have special situations that require them to be treated as employees for certain employment tax purposes, like types of delivery drivers, salesmen, those assembling items at home or a life insurance agent. The three categories of statutory nonemployee are fairly simple: licensed real estate agents, direct sellers and certain companion sitters. Click on the links if you’d like to read the full description on the IRS website.

And as for categorizing independent contractors and employee—well, it’s not an exact science. There is no single factor that is decisive in determining a worker’s status, as the individual circumstances of each case will determine how the IRS’ axe will fall. The basic rule is this: Independent contractors generally control the manner and means by which their contracted work (i.e. services, products or results) is achieved. For instance, an employee may have a deadline for a project, but their employer deems that they have to work on it from 8 a.m. to 5 p.m. during normal office hours and at the employer’s office. An independent contractor, for instance, may have the same deadline for a project, yet they can do it working 36 straight hours at home in their pajamas, or for one hour a day for two weeks, as long as they provide the results they were hired to do.

There are 20 factors that the IRS will consider when determining employee vs. independent contractor relationship.  The first five are as follows:

  1. Level of Instruction: If the company dictates to the worker when, where and how the work must be done, that level of control leans towards an “employee” status.
  2. Amount of Training: If you need to direct the worker in the methods of how the work should be done, i.e. sending them to company-provided training, this suggests an employee status.
  3. Degree of Business Integration: If the worker’s services are integrated into day-to-day business operations or they significantly affect business success, that worker is likely to be considered an employee.
  4. Extent of Personal Services: Independent contractors are usually free to assign the work in the project’s scope to whomever they choose, whereas a company will insist on a particular person performing the work (for instance, covered under an employee’s job description), which indicates an employee relationship.
  5. Control of Assistants: Have you hired, supervised and paid that worker’s assistant? Then most likely this worker has an employee status, as an independent contractor maintains control over hiring, supervising and paying helpers.

Again, these are only the first five of 20 possible factors that can assess if your workers are employees or independent contractors. If you would like to read the remaining 15 factors, please leave a comment below and we would be happy to email them to you.

Also, don’t forget to ask us whether or not you should file an SS-8 form with the IRS to allow them to determine the worker’s classification. There are pros and cons to submitting the “Determination of Employee Work Status for Purposes of Federal Employment Taxes and Income Tax Withholding” form, so please don’t submit one until you’ve talked to us first.

Don’t let a misclassification of a worker cause you to be fined unnecessarily! We cut through the complex language of the IRS and translate it into words you can understand. Call now for your free consultation before it’s too late—1099s are due to your independent contractors by February 29th! Click here to fill out our online form, or call us directly on (714) 637-4552.

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