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Is Your Client an Employee or Independent Contractor? It Pays to Know the Difference

A lot of ink and hype have been expended lately about the drivers for a certain ride-hailing company, and whether those drivers are employees or independent contractors. But let’s put the “gig economy” aside for a while. It’s time to get back to basics.

The basics are important for businesses and their owners - and their workers’ tax preparers. The basics come from the Internal Revenue Service in the form of rules for employee-versus-contractor decisions.

So how do we tell the difference between an employee and a contractor? The IRS first says to look at whether there is withholding. An employer must withhold income taxes and pay Social Security, Medicare tax and unemployment tax on any wages paid to an employee. Employers do not, however, have to withhold or pay any taxes on payments to independent contractors.

Sometimes, though, this isn’t enough to make a determination. So the IRS has further guidance.

Who’s in Control?

For this, it’s important to understand the relationship between the business and the worker. If the business or employer controls what work is done and how it gets done, that shows behavioral control. If the business or employer has control of financial or certain other aspects of a worker’s job, that’s considered financial control.

Those “certain other aspects” include such things as deciding the extent of the worker’s investment in the facilities or tools used in performing services. This could mean requiring – or not requiring – a worker to have his or her own tools for the job. Also included is controlling whether the worker can make his or her services available to the relative market.  Lastly, does the employer control how the business pays the worker or whether the worker can make a profit or incur a loss?

What’s Their Relationship?

Perception also plays a part in the employee-versus-contractor determination – namely, how the employer and employee each perceive their respective roles in the relationship.

Evidence of this perception can encompass written documents describing the relationship the two parties intended to create; whether the business provides the worker with employee-type benefits such as insurance, pension plan, vacation or sick pay. The permanency of the relationship is also a factor.

Another issue is whether services performed by the worker are a key aspect of the regular business of the company, as is the extent of any unreimbursed employee expenses the worker may have.

No doubt, in some situations, all this can be a lot to wade through. But the IRS does have help for employers trying to determine the status of workers. Use Form SS-8, Determination of Worker Status for Purposes of Federal Employment Taxes and Income Tax Withholding.

For more information, check out IRS Publication 15-A, Employer’s Supplemental Tax Guide.

Bob Williams

Forget genes; I’ve got words in my DNA. Communication has been part of who I am nearly all my life. From a long career in radio news to another one in newspapers – and a University of Georgia journalism degree sandwiched between the two – language has been my life. I’ve also been fortunate to have learned the tax business from the ground up here at Drake, starting with 1040.com online forms some years ago before moving on to work on the Web. In all things tax-ish, we aim to give you tools you can use.

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