Employees or Independent Contractors? Here's How to Differentiate

Employees or Independent Contractors? Here's How to Differentiate

By Wiss (629 words)
Posted in Outsourced Accounting & Tax on June 02, 2015

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By Donna Woronka

You think you’ve hired an independent contractor, but the IRS or State Department of Labor may see that you’ve hired an employee. If there’s any uncertainty, chances are good that you’ll lose that argument, and at a high cost in back payroll taxes and penalties. That’s why it’s critical that you understand the differences between the two legal classifications and that you keep your independent contractors independent. 

Here are some questions to help you determine  the correct relationship. 

  • Behavior control. Do you have say over when, where and how a job will be done? Will you train this individual? Will you provide him or her with feedback on the details of job performance? If yes, chances are the individual is an employee. You can tell an employee how to do a job, how long it should take and which assignment to handle at any given moment. By contrast, an independent contractor has more control over his or her behavior. Independent contractors typically decide what they will do, how they will do it and in what order. 
  • Exclusivity. Are the individuals in their own business? Do they have other customers? If not, they are likely employees. However, even if they do have a legitimate business, you need to be careful. If you are their only customer, and they are not actively soliciting more business, you could be in the danger zone. Aside from a start-up, an independent contractor typically has more than one customer and is only available to work for you a portion of the time. Start by seeing if they have a website, for example, to promote their business. 
  • Open-endedness of relationship. What and who will determine when the relationship will end? Aside from temporary help, your employees work for you on an ongoing basis, usually with no predetermined end date. Independent contractors typically work project to project. When the assignment is completed, the contractor moves on — or takes on another assignment at your company, also with an end date. 
  • Equipment and supplies. Do you provide the individuals with the tools they need to do their job? Employees are not expected to bring their own office equipment, tools or supplies to work. Independent contractors, however, are typically responsible for everything they need to get the job done. 
  • Worker’s understanding of arrangement. How and when does the individual expect to be paid? Employee are paid on a regular, recurring basis, whether or not they did their job, and regardless of the quality of their work. By contrast, independent contractors typically do not get paid until they finish the job or meet certain predetermined milestones. Unless other arrangements are made in advance, an independent contractor commonly invoices a customer and submits for payment. The customer has more freedom to withhold payment or dispute the bill if the quality of the work is poor or incomplete. 

While the above is not an all-inclusive list of issues to consider, it gives you an idea of the differences between the two classifications. If you find yourself in a grey area, you can ask the IRS to make a determination by completing Form SS-8. (This form can be obtained at www.irs.gov.) However, the downside is that it could take up to six months for the IRS to respond. And just because the IRS recognizes your situation one way does not guarantee that your state will agree. 

If in doubt, hire the individual as an employee. This way, you won’t lose sleep about the possibility of an IRS or state audit, followed by a demand for back payroll taxes and penalties for employees you didn’t even know you had. 

Donna Woronka, MBA, is a Manager of Client Services at Wiss. She specializes in providing clients with cloud-based accounting services. Reach her at dworonka@wiss.com.

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