Independent Contractor or Employee
Properly classifying a worker as an independent contractor may save your company money and benefits, such as pension, group health, workers' compensation insurance, social security taxes and unemployment taxes. Classifying workers as employees requires you to withhold social security, federal income and state income taxes and file payroll reports. You are liable for FICA and unemployment taxes. Employees may also have rights to various fringe benefits.
Intentionally misclassifying employees as independent contractors may result in substantial penalties and interest, double the amount that should have been withheld by the employer from the employee's wages. Unintentional misclassification of an employee is serious, but not as serious as the risk for an intentional misclassification.
An unintentional misclassification of an employee, but having filed a form 1099-MISC, limits the employer's liability for income taxes to 1.5% of the employee's wages. The employer's liability for FICA taxes that should have been paid by the employee would be limited to 20% of that amount. The employer has no rights to recover from the employee what is due IRS. If the employer did not file a form 1099-MISC, the percentage amounts are doubled. The employer is liable for its share of the FICA and unemployment taxes, plus penalties and interest.
An intentional misclassification of an employee could result in the employer owing IRS the full amount of income tax that should have been withheld (with an adjustment if the employee has paid or does pay part of the tax); the full amount of both the employer and employee shares for FICA taxes (with possibly an offset if the employee paid self-employment taxes); interest; and penalties.
The determination of whether a worker is an employee or an independent contractor usually depends on the extent of control and direction the person receiving the service has with regard to what is done and how it is done. An employer has the right to control how an employee performs the service, while an independent contractor determines for himself how the work is to be performed.
To determine if an individual is an independent contractor, the following 20-Factor Control test should be used.
- Instructions. If the person receiving the benefit of the service has the right to control the manner, the method of performance and when it is performed, this suggests an employer/employee relationship.
- Training. Individuals who are trained to perform a job in a particular manner are usually considered employees. An independent contractor does not receive any special training from the purchaser of his services.
- Integration. Whether the service performed is an integral part of the recipient's business rather than an ancillary portion can determine the worker's status. If the services performed are integrated into the operations of the business, this indicates that the worker is subject to control and direction, and therefore, an employee.
- Personal Services. If the business requires that the services be performed in person and the employer has substantial interest in how the results will be achieved, this suggests control over an employee.
- Use of assistants. An independent contractor hires, directs, and pays for his own assistants; supplies his own materials; and works under a contract providing that the worker is responsible only to achieve certain results.
- Ongoing relationship. Whether part-time, seasonal, or just irregular, ongoing work suggests the worker is an employee.
- Fixed hours of work. Independent contractors set their own hours.
- Full time work. This suggests employee status since this controls the time of work and restricts the worker from taking other jobs.
- Work location. If a worker performs services off of the employer's premises, this suggests independent contractor status.
- Work flow. Routines, schedules, and patterns established by the employer for a worker indicate employee status.
- Reports. Requiring written or oral reports suggests employee status.
- Manner of payment. Being paid by the hour, week, or month suggests employee status. Being paid a lump sum for a job suggests independent contractor status.
- Payment of expenses. Who pays expenses indicates who has control - the employer or the independent contractor.
- Tools and Equipment. Whether the worker rendering the service has a substantial investment in his own tools or equipment will also suggest employment status.
- Investment. If the worker has a significant investment in his own work facilities, tools and equipment, this implies independent contractor status.
- Profit or Loss. If the worker performing the service has an opportunity for profit dependent on his management skills and has a risk of loss, this implies independent contractor status.
- Multiple clients. If the worker who performs the services offers such services publicly and practices an independent trade, this indicates an independent contractor.
- Marketing. Independent contractors usually market their services to the public on a regular basis.
- Right to discharge. If the person who receives the services has the right to discharge, without cause, the person who performs the services, there is an employer/employee relationship. An independent contractor usually can only be dismissed if the contract specifications are not met.
- Right to quit. An independent contractor may be liable for failure to perform according to the contractual terms, while an employee may quit any time without liability.
Whether an individual is determined to be an independent contractor or an employee, it is required that you obtain his complete name, social security number and address before any money is paid. If this information is not obtained, you are required to withhold 31% for federal income taxes.
Form 1099-MISC must be filed with IRS for any amounts paid to an individual for services in excess of $600.00 during the calendar year. The due date for distribution of the form 1099-MISC to the independent contractor is January 31st of the following year. Form 1099 with its transmittal form 1096 must be filed with IRS by February 28th of the following year.
When a worker is correctly classified as an independent contractor, we recommend that you receive a Certificate of Insurance, a copy of the worker's business license, his federal employer's identification number, a business card, and have him provide you a written bill for his services. These documents will help support your position that the worker has been correctly classified, especially if he operates as a proprietorship. They will also help reduce your workers' compensation insurance premiums and unemployment taxes.