As the employer, it is very important that you correctly determine whether the individuals providing services to you are employees or independent contractors. Generally, you must withhold income taxes, withhold and pay Social Security and Medicare taxes, and pay unemployment tax on wages paid to an employee. You do not generally have to withhold or pay any taxes on payments to independent contractors.
Before you can determine how to treat payments you make for services, you must first know the business relationship that exists between you and the person performing the services.
The general rule is that an individual is an independent contractor if you, the person for whom the services are performed, have the right to control or direct only the result of the work and not the means and methods of accomplishing the result.
Classifying as Independent Contractor
In determining whether the person providing services is an employee or an independent contractor, all information that provides evidence of the degree of control and independence must be considered.
Facts that provide evidence of the degree of control and independence fall into three categories:
- Behavioral control - does the company control or have the right to control what the worker does and how the worker does his or her job?
- Financial control - are the business aspects of the worker's job controlled by the payer?
- Type of relationship - are there written contracts or employee-type benefits, will the relationship continue and is the work performed a key aspect of the business?
The Internal Revenue Service (IRS) developed 20 factors to assist the taxpayer in determining if a worker is an employee or independent contractor.
A "Yes" answer for the following questions indicates that the worker is an employee:
- Does the business provide instructions to the worker about when, where and how he or she is to perform the work?
- Does the business provide training to the worker?
- Are the services provided by the worker integrated into the business' operations?
- Must the services be rendered personally by the worker?
- Does the business hire, supervise and pay assistants to the worker?
- Is there a continuing relationship between the business and the worker?
- Does the business set the work hours and schedule?
- Does the worker devote substantially full time to the work of the business?
- Is the work performed on the business' premises?
- Is the worker required to perform the services in an order or sequence set by the business?
- Is the worker required to submit oral or written reports to the business?
- Is the worker paid by the hour, week or month?
- Does the business have the right to discharge the worker at will?
- Can the worker terminate his or her relationship with the business any time he or she wishes without incurring liability to the business?
- Does the business pay the traveling expenses of the worker?
A "Yes" answer for the following questions indicates that the worker is an Independent Contractor:
- Does the worker furnish significant tools, materials and equipment?
- Does the worker have a significant investment in the facilities?
- Can the worker realize a profit or loss as a result of his or her services?
- Does the worker provide services for more than one firm at a time?
- Does the worker make his or her services available to the general public?
Determination is Employer's Responsibility
The determination of whether or not the worker is an employee or independent contractor is the responsibility of the business. If the IRS challenges the classification made by the business, the employer must prove that the person is an independent contractor.
You may request a determination of whether a worker is an employee or independent contractor from the IRS. This request is done by filing Form SS-8, Determination of Employee Work Status for Purposes of Federal Employment Taxes and Income Tax Withholding.
Forms and Taxes for Independent Contractors
Once a determination that one is an independent contractor is made, the next step is filing the appropriate forms and paying the associated taxes.
If you've made the determination that the person you're paying is an independent contractor, the first step is to have the contractor complete Form W-9, Request for Taxpayer Identification Number and Certification. This form can be used to request the correct name and Taxpayer Identification Number, or TIN, of the worker.
Form 1099-MISC is most commonly used by payers to report payments made in the course of a trade or business to others for services. If you paid someone who is not your employee $600 or more for services provided during the year, a Form 1099-MISC needs to be completed, and a copy of 1099-MISC must be provided to the independent contractor by January 31 of the year following payment. You must also send a copy of this form to the IRS by February 28 or March 31 if you use the Filing Information Returns Electronically (FIRE) system.
Employers sometimes improperly classify their employees as independent contractors so that they, the employer, do not have to pay payroll taxes, pay the minimum wage or overtime, comply with other wage and hour law requirements such as providing meal periods and rest breaks or reimburse their workers for business expenses incurred in performing their jobs. Additionally, employers do not have to cover independent contractors under workers' compensation insurance, and are not liable for payments under unemployment insurance, disability insurance or Social Security.
If you classify an employee as an independent contractor and you have no reasonable basis for doing so, you may be held liable for employment taxes for that worker.
Misclassified Workers Can File Social Security Tax Form
Workers who believe they have been improperly classified as independent contractors by an employer can use Form 8919, Uncollected Social Security and Medicare Tax on Wages to figure and report the employee's share of uncollected Social Security and Medicare taxes due on their compensation.
Employer not Liable for Acts of Independent Contractor
An employer is generally not liable for physical harm and damage caused to another by an act of an independent contractor.