Tax Pro Plus Small Business Winter Tax Tips - Employee or Independent Contractor?

This classification determines if payroll taxes are required.

For some business owners, determining whether a worker is an employee or an independent contractor can be tricky. Generally, you must withhold income taxes, withhold and pay social security and Medicare taxes and pay unemployment tax on wages paid to an employee. However, you don’t generally have to withhold or pay any taxes on payments made to independent contractors.

There is a misconception that you may be able to choose which classification works best for your company. In reality, however, the facts and circumstances impose the worker status. In determining whether the person providing a service is an employee or an independent contractor, you must consider all information that provides evidence of the degree of control and independence. You’ll need to answer these four questions:

1. Does the company control or have the right to control what the worker does and how the worker does his or her job?

2. Are the business aspects of the worker’s job controlled by the payer? Examples include how a worker is paid, whether expenses are reimbursed and who provides tools/supplies.

3. Are there written contracts or employee-type benefits like a pension plan, insurance, vacation pay?

4. Will the relationship continue and is the work performed a key aspect of the business?

Businesses must weigh all these factors when determining whether a worker is an employee or independent contractor. Some factors may indicate that the worker is an employee, while other factors indicate that the worker is an independent contractor. No set number of factors makes the worker an employee or an independent contractor and no single factor stands alone in making this determination. The concept is to look at the entire business relationship, consider the degree or extent of the right to direct and control, and finally, to document each of the factors used in coming up with the determination.

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. File a Form SS-8 with the IRS if the factors for determining worker status remain unclear.