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Employee vs. Contractor: The Definition that Matters

2/11/2013

3 Comments

 
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As your company starts to grow, and you begin to hire individuals to help you keep up with expansion, there is the daunting task of determining whether you should be hiring individuals as employees, or as independent contractors. Why does it matter? I’ll tell you why: the IRS cares, and so should you. If you misclassify your new hire, you will be liable for employment taxes for that worker. To avoid the unpleasant series of consequences, we offer guidance to avoid this misstep.




Classifying a new hire means understanding the differences between independent contractors and employees. Independent contractors are usually self-employed individuals who offer their services to the general public. Services performed by independent contractors are not controlled by an employer; specifically, “what will be done and how it will be done” will not be controlled by the employer. Conversely, an employee is an individual who performs services for an employer if the employer can control “what will be done and how it will be done”. To make this point clear, let’s look at the following example:

Sally Sales is employed by a startup company. Sally works in sales, but any final deal she offers a client must be approved by her manager. Her work is very independent in nature otherwise. The company pays for her health insurance and benefits. This is an example of an employee. Had Sally done her work without approval of a manager and was not offered insurance or benefits, she would be an independent contractor. The more you find yourself controlling the work of your new hire, the more likely the new hire is an employee.

There is no clear-cut measurement of qualities or characteristics that help determine the role of your new hire. However, consideration of the following three categories can help you define the capacity in which your new hire will be integrated into your business:

    Behavioral - Will the new hire have the right to control or direct only the result of the work? Will you as an employer control the services of the new hire (specifically, “what will be done and how it will be done”)?

    Financial- Are the business aspects of the new hire’s work controlled by the employer (i.e., how the new hire is paid and reimbursed, tools provided, etc.)?

    Type of Relationship – Is there an employer-employee relationship (are benefits offered, insurance, vacation pay, etc.)?

If, after considering the categories above you are still concerned about the status of a new hire, you have the option of submitting Form SS-8, Determination of Worker Status for Purposes of Federal Employment Taxes and Income Tax Withholding Form, to the IRS to help you classify your new hires. Please note that it may take at least six months to receive a final determination.

Once you have classified the nature of your new hire, you must prepare to collect taxes, or file the correct tax forms. If you find yourself hiring an employee, you will be withholding federal income tax from your new hire’s wages, and preparing a W-2 for your employee at the end of the year.  If you have hired an independent contractor, you will need to have the contractor fill out a Form W-9, Request for Taxpayer Identification Number and Certification. At the end of the year, you will be completing a Form 1099-MISC to report payments made to the contractor.

It seems daunting at first, but considering a few questions about the nature of your new hire can save you the headache of paying for the mistake of misclassifying them later. Happy Hiring!

   For more information on both the Federal Government and State of California's definitions of Contractors and Employees, see the links below.

IRS Website
State of California Department of Industrial Relations
3 Comments
virginia employment law link
8/6/2013 07:20:31 pm

To understand such a law, we need to have a lawyer.

Reply
George Grey link
10/3/2013 04:32:34 pm

It is extremely important to understand the difference between employee and independent contractor. As the wrong interpretation can lead to penalty from IRS. You have mentioned some excellent points that an organization can considered on deciding whether it has hired a contractor or employee.

Reply
american continental insurance medicare supplement link
10/21/2013 05:35:28 am

Of great importance is to have good health insurance

Reply



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