The distinction between an employee and an independent contractor is a little-understood area of the law for employers and employees alike. But, it is essential to determine in which category a worker fits in order to make sure that the worker is paid correctly and also to make sure that the applicable tax laws are satisfied. If the worker is an employee, state, federal and sometimes local employment taxes (commonly referred to as “payroll taxes”) must be paid by both the employer and the employee. Payroll taxes typically are not owed where the worker is an independent contractor. The IRS is often the entity that makes the final determination of whether a worker is an independent contractor or an employee, and the tax consequences resulting from a misclassification can be severe.
Mere use of a title does not determine whether the worker is an employee or an independent contractor. Instead, the employer’s level of control over the worker generally determines whether he or she is an employee or an independent contractor. A good rule of thumb is that the more control the employer exercises, the greater the likelihood that the worker must be classified as an employee for purposes of determining wages and calculating taxes. The less control the “employer” exercises, the greater the likelihood that the worker can be classified as an independent contractor for purposes of determining wages and calculating taxes.
Factors that the IRS considers in determining whether a worker is an employee or an independent contractor include the following:
1. Who decides how and when the worker will perform his/her duties? If the worker is merely told of the desired end result and then decides for him/herself how to achieve the end result, then the worker is more likely to be an independent contractor. If the employer specifies how tasks will be performed, it is more likely that the worker will be deemed an employee. For example, where the business simply requests that the worker research and prepare a report on a particular subject by a date certain, without providing guidance regarding how the report is to be researched and prepared, the worker looks more like an independent contractor. But, if the business specifies that the worker must use specific source materials, work on the report at company offices during specific hours, and/or seek input from a supervisor while preparing the report, the worker looks more like an employee. Variations along this spectrum will determine whether the IRS is more likely to conclude that the worker is an employee or an independent contractor.
2. Does the worker receive reimbursement for expenses incurred in connection with the performance of assigned tasks? Who provides the worker’s tools – the employer or the worker? Typically, an employer will provide the tools for its employees to use – such as computers, copiers, drills, or whatever else the employee needs to perform his/her job – and reimburse the employee’s work-related expenses. In contrast, independent contractors generally own and control their own equipment, including computers, mechanical tools, and anything else the job may require, and are responsible for paying for their own expenses out of their income.
3. Do the worker and the “employer” perceive that the worker is independent or dependent on the guidance of the “employer”? Has the arrangement been memorialized in writing, and if so are the employer and the employee complying with the terms of the written agreement? A written description of the respective roles of the “employer” and the worker can not only prevent misunderstandings between the “employer” and the worker, but also serve as strong evidence as to the parties’ intent as between independent contractor status and the status of being an employee.
Because the ultimate determination of whether the worker is an employee or an independent contractor will depend on the specific facts applicable to each worker’s situation, it is impossible to state with certainty in an article of this type which workers are more or less likely to be deemed employees or independent contractors. Although the general guidelines set forth in this article may assist an employer or employee in making this determination in many cases, in close cases it is important to consult with counsel. Employers and workers also have the option of completing an IRS Form SS-8 (available at www.irs.gov) and requesting a determination of status from the IRS. This may be an appropriate step to take where everyone wants to have certainty as to the worker’s correct status at the outset of the relationship. This may also be a wise step to take where an employer intends to hire several workers with the same job description and does not want to risk facing an adverse tax determination as to multiple workers at a later date.
The analysis set forth in this article is provided for general understanding only and should not be considered legal advice. Counsel should always be consulted for advice regarding a specific situation.
