Q: Tax Playa, what are the rules on employees vs. independent contractors?
Mike, Bethesda MD
A: If you are in business and people are doing work for you, they fall into one of two broad categories: employees or independent contractors. The tax implications for both are quite different, as is the way that you must treat them...
For more information on this, please consult IRS Publication 15A, Employer's Supplemental Tax Guide.
The normal default if someone is doing work for you is to treat them as an employee. Employers are required to withhold for income tax and FICA (Social Security and Medicare tax). Employers must also pay unemployment tax.
There are three types of employees:
- Common Law Employees. By far the most prevalent kind. A common law-employee relationship is one in which the employer has the right to control the work and how it will be done.
- Statutory Employees. Income tax is not withheld for these employees, but Social Security and Medicare tax (FICA) usually is. There are four categories of these kind of employees--delivery drivers, full-time life insurance salesmen, individuals who work at home with materials the employer provides, and full-time traveling salesmen.
- Statutory Non-employees. These are persons treated as independent contractors. They must be compensated based on commission, and must sign a contract saying that they are not employees. Only direct sellers, realtors, and companion sitters can be statutory non-employees.
As a general rule, a worker is an independent contractor if a business owner hires him to perform a task, but surrenders control over how that task is to be accomplished.
Unlike for employees, business owners are not required to withhold FICA or income tax for independent contractors, nor required to pay unemployment tax. Rather, a 1099-MISC is issued to any independent contractor who earns more than $600 from a business owner in a year.
There are 20 tests over 3 broad factors to determine if someone is an independent contractor. The more tests that are met, the more likely it is that the independent contractor status will hold up (the following indications are written in a way that suggests the person is an employee):
1. Behavioral Control
- When and where to do the work
- What tools or equipment to use
- What workers to hire or assist with the work
- Where to purchase supplies and services
- What work must be performed by a specified individual
- What order or sequence to follow
- Training has been given to the worker
- Services are rendered personally by the worker
- Oral or written reports required
2. Financial Control
- The worker has been reimbursed for expenses
- The worker does not have any investment at risk
- The worker cannot make the services generally available to the open market
- The worker is not performing tasks for more than one business
- The worker is paid regularly, not as a flat fee
- The worker cannot realize a profit or loss
- The worker can quit without realizing a financial liability
3. Type of Relationship
- There is not a written contract between the employer and the worker
- The worker is provided fringe benefits
- The relationship between the employer and the worker has no fixed end date
- The services performed by the worker are a key element of the company