Contractor or Employee?

Knowing the difference is important
Is a worker an independent contractor or an employee? This seemingly simple question is often the contentious subject of IRS audits. As an employer, getting this wrong could cost you plenty in the way of Social Security, Medicare, and other employment-related taxes. Here is what you need to know.
The basics
As the worker. If you are a contractor and not considered an employee you must:
  •  Employee Pay self-employment taxes (Social Security and Medicare-related taxes)
  •  Employee Make estimated federal and state tax payments.
  • Employee Handle your own benefits, insurance and bookkeeping.
As the employer. You must ensure your employee versus independent contractor determination is correct. Getting this wrong in the eyes of the IRS can lead to:
  •  Employer Payment and penalties related to Social Security and Medicare taxes.
  •  Employer Payment of possible overtime including penalties for a contractor reclassified as an employee.
  •  Employer Legal obligation to pay for benefits.
  • Things to consider
When the IRS recharacterizes an independent contractor as an employee they look at the business relationship between the employer and the worker. The IRS focuses on the degree of control exercised by the employer over the work done and they assess the worker's independence. Here are some guidelines:
  • Bullet Point Consider The more the employer has the right to control the work (when, how and where the work is done), the more likely the worker is an employee.
  • Consider The more the financial relationship is controlled by the employer the more likely the relationship will be seen as an employee and not an independent contractor. To clarify this, an independent contractor should have a contract, have multiple customers, invoice the company for work done, and handle financial matters in a professional manner.
  • Consider The more businesslike the arrangement the more likely you have an independent contractor relationship.
While there are no hard-set rules, the more reasonable your basis for classification and the more consistently it is applied, the more likely an independent contractor classification will not be challenged.