Employee or Independent Contractor?

Knowing your worker status is critical because it determines who is responsible to withhold income taxes and pay Social Security, Medicare taxes, and unemployment tax on wages. People are often surprised to receive a 1099-MISC income form at the end of the year, soon accompanied by a large tax bill when your return is filed. Moreover, if you were not paying estimated taxes during the year, you may incur an estimated tax penalty.

According to the IRS, the general rule is that an individual is an independent contractor if the payer has the right to control or direct only the result of the work and not what will be done and how it will be done. However, the IRS weighs worker status on a case-by-case basis.

To help make this determination, the IRS looks at three factors: behavioral control, financial control, and the relationship of the parties.

The behavioral control factor looks at who has the right to control your behavior at work. The IRS is more likely to consider you an employee if the business provides highly-detailed instructions, has systems in place to measure your performance, and gives you instructions on when and where to work, what tools to use, and/or where to purchase supplies and services.

The second factor determines who has financial control over the business aspects of your job. You will more likely be considered an employee if you don't significantly invest in your work equipment, you don't typically have many unreimbursed expenses, and you do not have the opportunity for profit or loss. If your services aren't available to the marketplace, and the business guarantees you a regular wage for hourly, weekly, or other periodic work (even if you also get a commission), you will more likely be considered an employee. Also, independent contractors often charge flat fees for a job.

The third factor examines your relationship with the business. You are more likely to be considered an employee if you have a written contract that states you are an employee, you receive employee-type benefits such as insurance, a pension plan, or vacation or sick pay. If the business expects the relationship to continue indefinitely (rather than for a specific project or period) and you provide services that are a key activity of the business, you may lean toward an employee/employer relationship. Companies generally don't grant benefits or indefinite job opportunities to independent contractors.

The IRS also offers the Voluntary Classification Settlement Program which allows employers to reclassify as employees those workers they have erroneously treated as independent contractors. The program has generous payment terms, and participants get relief from employment tax audits for previous years.

Please feel free to contact Kakenmaster & Associates, and we can help determine your worker status or that of your employees.