Employee or Independent Contractor
If you hire someone for a long-term, full-time project or a series of projects that are likely to last for an extended period, you must pay special attention to the difference between independent contractors and employees.
Why It Matters
The Internal Revenue Service and state regulators scrutinize the distinction between employees and independent contractors because many business owners try to categorize as many of their workers as possible as independent contractors rather than as employees. They do this because independent contractors are not covered by unemployment and workers’ compensation, or by federal and state wage, hour, anti-discrimination, and labor laws. In addition, businesses do not have to pay federal payroll taxes on amounts paid to independent contractors.
Caution: If you incorrectly classify an employee as an independent contractor, you can be held liable for employment taxes for that worker, plus a penalty.
The Difference Between Employees and Independent Contractors
Independent Contractors are individuals who contract with a business to perform a specific project or set of projects. You, the payer, have the right to control or direct only the result of the work done by an independent contractor, and not the means and methods of accomplishing the result.
Example: Sam Smith, an electrician, submitted a job estimate to a housing complex for electrical work at $16 per hour for 400 hours. He is to receive $1,280 every 2 weeks for the next 10 weeks. This is not considered payment by the hour. Even if he works more or less than 400 hours to complete the work, Sam will receive $6,400. He also performs additional electrical installations under contracts with other companies that he obtained through advertisements. Sam Smith is an independent contractor.
Employees provide work in an ongoing, structured basis. In general, anyone who performs services for you is your employee if you can control what will be done and how it will be done. A worker is still considered an employee even when you give them freedom of action. What matters is that you have the right to control the details of how the services are performed.
Example: Sally Jones is a salesperson employed on a full-time basis by Rob Robinson, an auto dealer. She works 6 days a week, and is on duty in Rob’s showroom on certain assigned days and times. She appraises trade-ins, but her appraisals are subject to the sales manager’s approval. Lists of prospective customers belong to the dealer. She has to develop leads and report results to the sales manager. Because of her experience, she requires only minimal assistance in closing and financing sales and in other phases of her work. She is paid a commission and is eligible for prizes and bonuses offered by Rob. Rob also pays the cost of health insurance and group term life insurance for Sally. Sally Jones is an employee of Rob Robinson.
Independent Contractor Qualification Checklist
The IRS, workers’ compensation boards, unemployment compensation boards, federal agencies, and even courts all have slightly different definitions of what an independent contractor is, though their means of categorizing workers as independent contractors are similar.
One of the most prevalent approaches used to categorize a worker as either an employee or independent contractor is the analysis created by the IRS. The IRS considers the following:
- What instructions the employer gives the worker about when, where, and how to work. The more specific the instructions and the more control exercised, the more likely the worker will be considered an employee.
- What training the employer gives the worker. Independent contractors generally do not receive training from an employer.
- The extent to which the worker has business expenses that are not reimbursed. Independent contractors are more likely to have unreimbursed expenses.
- The extent of the worker’s investment in the worker’s own business. Independent contractors typically invest their own money in equipment or facilities.
- The extent to which the worker makes services available to other employers. Independent contractors are more likely to make their services available to other employers.
- How the business pays the worker. An employee is generally paid by the hour, week, or month. An independent contractor is usually paid by the job.
- The extent to which the worker can make a profit or incur a loss. An independent contractor can make a profit or loss, but an employee does not.
- Whether there are written contracts describing the relationship the parties intended to create. Independent contractors generally sign written contracts stating that they are independent contractors and setting forth the terms of their employment.
- Whether the business provides the worker with employee benefits, such as insurance, a pension plan, vacation pay, or sick pay. Independent contractors generally do not get benefits.
- The terms of the working relationship. An employee generally is employed at will (meaning the relationship can be terminated by either party at any time). An independent contractor is usually hired for a set period.
- Whether the worker’s services are a key aspect of the company’s regular business. If the services are necessary for regular business activity, it is more likely that the employer has the right to direct and control the worker’s activities. The more control an employer exerts over a worker, the more likely it is that the worker will be considered an employee.
Minimize the Risk of Misclassification
If you misclassify an employee as an independent contractor, you may end up before a state taxing authority or the IRS.
Sometimes the issue comes up when a terminated worker files for unemployment benefits and it’s unclear whether the worker was an independent contractor or employee. The filing can trigger state or federal investigations that can cost many thousands of dollars to defend, even if you successfully fight the challenge.
There are ways to reduce the risk of an investigation or challenge by a state or federal authority. At a minimum, you should:
- Familiarize yourself with the rules. Ignorance of the rules is not a legitimate defense. Knowledge of the rules will allow you to structure and carefully manage your relationships with your workers to minimize risk.
- Document relationships with your workers and vendors. Although it won’t always save you, it helps to have a written contract stating the terms of employment.
If you have any questions about how to classify your employees, please give us a call. We can help guide you in the right direction in the eyes of the IRS.
Eternal Payroll Question: Employee or Independent Contractor?
This is a guest post. Thanks to everyone who is helping.
Employee or Independent Contractor?
We’ve all heard of independent contractors, and most of us have been hired as an employee, however, what classifies a worker as one but not the other? This important question must be addressed by business owners upon new additions to their team.
Employees live in a world of limitations: they work in the constraints of their employer, who in turn determine their hours and monitor what skills and equipment are used. A person who works full-time is entitled to employment benefits such as healthcare and 401-K compensation. New hires are required to complete a Form W-4 (Employee Withholding Allowance Certificate), which dictates their tax withholding. Employees can use a tax calculator to prevent having too much or too little Federal income tax withheld from their pay.
In contrast to regular employees, an independent contractor performs a role with fewer restrictions. Because they’re essentially self-employed, they are allowed more flexibility in their schedules and can perform more at their own-pace. They are defined by common law principles of The Fair Labor Standard Act, which focuses on the level of control an employer has over a service or product. There is either a verbal or written contract of their services; many times this will not include permanent employment. Independent contractors oftentimes do not rely on their business as the sole source of income.
Due to the somewhat disconnected nature of this form of labor, independent contractors are ineligible for employer-provided benefits. In terms of tax forms and preparations, the employer is not required to compile a W-2 or report payroll for these workers. What an independent contractor must then do, is save the tax money that gets automatically taken out of an employee’s paycheck. From there, you will need to fill out a Form W-9 (for a taxpayer identification number), as well as Form 1099-MISC (miscellaneous income form) and prepare to file quarterly.
Even with these distinctions, sometimes the area between an employee and an independent contractor is still murky. In these instances, Form SS-8 will help determine the difference between the two. The assistance of a tax preparer will greatly facilitate the process and limit the likelihood of a tax misfiling. For businesses and individuals to file taxes correctly, the appropriate classification of employment must be known.
Guest contributor Andrea Fisher is an online marketer and content specialist from North Carolina. She is a published journalist with an English degree and political science minor from the University of North Carolina at Greensboro.
Form 1099 Rules & Regulations
Here are some guidelines to help determine if a vendor needs to be set up as a 1099 vendor.
Who must file Form 1099?
Persons engaged in a trade or business must file Form 1099 MISC when certain payments are made. A person is engaged in business if he or she operates for profit; thus, personal payments aren’t reportable.
Payments to Report
A Form 1099 MISC must be filed for each person to whom payment is made of:
- $600 or more for services performed for a trade or business by people not treated as employees;
- Backup Withholding (all amounts);
- Rent or prizes and awards that are not for service ($600 or more) and royalties ($10 or more);
- All payments to crew members by owners or operators of fishing boats;
- Payments of $600 or more to a supplier of health and medical services; and
- Crop insurance proceeds.
Payments made to corporations, except those made for medical or health care services and attorney fees, are not required to be reported on Form 1099 MISC.
Non-Employee payments – Non-employee payments are reported in Box 7 of Form 1099 MISC. Non-employee payments include fees, commissions, prizes and awards, and other forms of compensation provided for services performed for a trade or business by an individual who is not an employee. If the following four conditions are met, a payment generally is reportable as non-employee compensation:
- The taxpayer made the payment to someone who is not an employee;
- The payment was made for services in the course of a trade or business;
- The payment was made to someone other than a corporation; and
- Payments of at least $600 were made to the payee during the year.
Real Estate Agents
Real estate agents must report on Form 1099 MISC rents collected for property owners before deduction of commissions, fees, or other expenses if the amount paid to any one property owner totals $600 or more during the calendar year.
Payments for Services
When a business pays an independent contractor for services performed in the course of that business, the service recipient must file Form 1099 MISC if the payment is $600 or more for the year, unless the service provider is a Corporation.
Direct Sales
The law requires information reporting on Form 1099 MISC for certain direct sellers. This requirement applies to persons who, in the course of a business, sell consumer products on a buy/sell basis, deposit/commission basis, or any similar basis to any buyer who (1) sells such product in a home or other than in a store or (2) sells these products to another seller. Sales of $5000 or more are reportable.
Deceased Employee Wages
If an employee dies during the year, the employer must report the accrued wages, annual leave pay, and other compensation paid to an estate or beneficiary after death on Form 1099 MISC; this applies whether the payment is made in the year of death or after the year of death.
Listed below are a few examples of payments that should be reported on Form 1099-MISC
Medical Services
- Medical & Dental Services
- Hospitalization
- Medical Assistance Benefits
- All payments to Medical Service Corporations
Non-Employee Compensation
- Occasional Salaries & Wages (to Non-Employees)
- Professional Service Payments
- Advertising
- Appraisal
- Architectural
- Attorney
- Auditing
- Board Members
- Chaplains
- Computer Programming
- Consulting
- Design & Testing
- Engineering
- Evaluation Consultant
- Graphic Artist
- Institution Contracts
- Teacher/Instructor
Maintenance & Repairs
- Commercial Repairs – Hwy Vehicles
- Contracted Repairs
- Computer Repairs
- Extermination Services
- Janitorial Services
- Maintenance Agreements
- Protection & Security Services
Law Enforcement & Court Services
- Court Reporters
- Court Appointed Workers
- Expert Witnesses
- Prison Labor Allowance
- Non-Employee Allowance
Other Services
- Armored Car
- Cleaning
- Construction
- Keypunch
- Laundry
- Parcel & Delivery
- Printing
- Refuse Collection
- Security
Rents (except rent paid to real estate brokers)
- Real Property
- Other Property
Note: This is only a partial listing of accepted 1099 MISC Vendors. If a vendor is entered as a 1099 vendor and it doesn’t look correct, the Vendor Maintenance team will research the problem. It may mean a phone call to the person who entered the vendor or a phone call to the vendor directly.
For more information Please visit my company website. L & R Tax Preparation.
Some Commonly Overlooked Small Business Deductions
Written by: Courtney Phillips
In the current economic climate, it is no surprise that people are looking for ways to save on their taxes. Over the last several years, many people have begun to telecommute, freelance, or work from home. These people often do not realize that there are many things that can be deducted from taxes as an independent contractor. Other small business owners may not realize what is deductible and what is not.
Whether you do your taxes on your own or use a tax professional to help you through the filing process, look into whether or not some of the following commonly overlooked small business deductions apply to your situation.
Office Space – If you have a dedicated office space in your home, you may be able to deduct the value of the square footage. There are some requirements that your office must meet, like being strictly used for business purposes.
Gift Deductions – Perhaps you have donated goods or services at some point throughout the last tax year. These gifts are often tax-deductible, so keep track of donations and gifts.
Office Supplies – Office supplies that are necessary to the functionality of your office and business can be tax-deductible. Make sure that you keep meticulous records of what you purchase for your office so that money can be accounted for later on down the road.
Communications – Office lines, dedicated cell phones, fax lines, and internet connections may all be tax-deductible, depending on your situation. These types of services are often necessary for operating a successful business and can give you a much-needed break come tax time.
Equipment – Purchasing new office equipment and other items needed to perform the tasks related to your business are generally tax-deductible as well. If you need to buy external hard drives, printers, or other hardware, keep track of your spending.
Professional Organizations, Memberships, and Fees – These things are all commonly overlooked tax deductions. If you belong to a particular group, subscribe to a trade journal, or keep memberships in order to meet with and entertain clients, you may be able to deduct these expenses as well.
Talk with a tax professional, like Bruce or visit www.irs.gov for more information regarding tax guidelines for business deductions.
This post was contributed by Courtney Phillips, who writes about how to obtain bachelors degree online (Bachelors Degree Online). She invites and welcomes your feedback at CourtneyPhillips80 at gmail.com
Be sure to check out the Carnival of Pecuniary Delights No. 1: The Madoline Hatter Pecuniary Art Edition. it is a must read for us all.
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