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Contractor or Employee - Knowing the Difference is Imperative

Contractor or Employee - Knowing the Difference is Imperative

BrookWeiner, LLC


Many companies have a tendency to be very loose about how they hire and classify their workers. What may appear to be a simple hiring to shore up a company’s busy period or to perform a special project, could have significant ramifications down the road, depending upon whether that individual is considered an employee or an independent contractor. 

Specifically, the question of whether a worker is an independent contractor or employee for federal income and employment tax purposes is a complex one. It is intensely factual, and the stakes can be very high. If a worker is an employee, the company must withhold federal income and payroll taxes, pay the employer's share of FICA taxes on the wages plus FUTA tax, and often provide the worker with fringe benefits it makes available to other employees. There may be state tax obligations as well. These obligations don't apply for a worker who is an independent contractor. The business sends the independent contractor a Form 1099-MISC for the year showing what he or she was paid (if it amounts to $600 or more), and that's it.

Who is an "employee?" There is no uniform definition of the term.

Under the common-law rules (so-called because they originate from court cases rather than from a statute), an individual generally is an employee if the enterprise he works for has the right to control and direct him regarding the job he is to do and how he is to do it. Otherwise, he is an independent contractor.

Some employers that have misclassified workers as independent contractors are relieved from employment tax liabilities under Section 530 of the 1978 Revenue Act (not the Internal Revenue Code). In brief, Section 530 protection applies only if the employer: 

  • filed all federal returns consistent with its treatment of a worker as an independent contractor; 
  • treated all similarly situated workers as independent contractors; 
  • and had a "reasonable basis" for not treating the worker as an employee. 

For example, a "reasonable basis" exists if a significant segment of the employer's industry has traditionally treated similar workers as independent contractors. Section 530 doesn't apply to certain types of technical services workers.

Individuals who are "statutory employees," (that is, specifically identified by the Internal Revenue Code as being employees) are treated as employees for social security tax purposes even if they aren't subject to an employer's direction and control (that is, even if the individuals wouldn't be treated as employees under the common-law rules). These individuals are agent drivers and commission drivers, life insurance salespeople, home workers, and full-time traveling or city salespeople who meet a number of tests. Statutory employees may or may not be employees for non-FICA purposes. Corporate officers are statutory employees for all purposes.

Individuals who are statutory independent contractors (that is, specifically identified by the Internal Revenue Code as being non-employees) aren't employees for purposes of wage withholding, FICA, or FUTA and the income tax rules in general. These individuals are qualified real estate agents and certain direct sellers.

Some categories of individuals are subject to special rules because of their occupations or identities. For example, corporate directors aren't employees of a corporation in their capacity as directors, and partners of an enterprise organized as a partnership are treated as self-employed persons.

Under certain circumstances, you can ask IRS (on Form SS-8) to rule on whether a worker is an independent contractor or employee.

If you would like to discuss with us how these complex rules apply to your business, and to make sure that none of your workers are misclassified, please call our office. 

 

Disclaimer: The information in this article is general in nature, and is not intended to be nor should it be treated as tax, legal, investment, accounting, or other professional advice. Before making any decision or taking any action, you should consult a qualified professional advisor who has been provided with all pertinent facts relevant to your particular situation.

© 2015 Thomson Reuters/Tax & Accounting. All Rights Reserved.