Subcontractor vs Employee Determination
Determining whether someone that assists your company is an employee or subcontractor can be tedious as best.
There are many articles in this blog that cover subcontractors including the Ladder of Insurance (c).
Even though each state has a definite set of laws on employees/subcontractors, the IRS website covers the comparison very thoroughly in easy to understand modules.
Below is the complete IRS webpage on subcontractors and employees. The IRS, of course, is mainly concerned with withholding taxes. However, the guide can be used for a quick reference on employee/subcontractor determinations. The IRS last updated the info below on 1/10/13.
Independent Contractor (Self-Employed) or Employee?
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It is critical that business owners correctly determine whether the individuals providing services are employees or independent contractors.
Generally, you must withhold income taxes, withhold and pay Social Security and Medicare taxes, and pay unemployment tax on wages paid to an employee. You do not generally have to withhold or pay any taxes on payments to independent contractors.
Select the Scenario that Applies to You:
- I am an independent contractor or in business for myself. If you are a business owner or contractor who provides services to other businesses, then you are generally considered self-employed. For more information on your tax obligations if you are self-employed (an independent contractor), see our Self-Employed Tax Center.
- I hire or contract with individuals to provide services to my business
If you are a business owner hiring or contracting with other individuals to provide services, you must determine whether the individuals providing services are employees or independent contractors. Follow the rest of this page to find out more about this topic and what your responsibilities are.
Before you can determine how to treat payments you make for services, you must first know the business relationship that exists between you and the person performing the services. The person performing the services may be –
- An independent contractor – full definition
- An employee (common-law employee)
- A statutory employee
- A statutory nonemployee
In determining whether the person providing service is an employee or an independent contractor, all information that provides evidence of the degree of control and independence must be considered.
Common Law Rules
Facts that provide evidence of the degree of control and independence fall into three categories:
- Behavioral: Does the company control or have the right to control what the worker does and how the worker does his or her job?
- Financial: Are the business aspects of the worker’s job controlled by the payer? (these include things like how worker is paid, whether expenses are reimbursed, who provides tools/supplies, etc.)
- Type of Relationship: Are there written contracts or employee type benefits (i.e. pension plan, insurance, vacation pay, etc.)? Will the relationship continue and is the work performed a key aspect of the business?
Businesses must weigh all these factors when determining whether a worker is an employee or independent contractor. Some factors may indicate that the worker is an employee, while other factors indicate that the worker is an independent contractor. There is no “magic” or set number of factors that “makes” the worker an employee or an independent contractor, and no one factor stands alone in making this determination. Also, factors which are relevant in one situation may not be relevant in another.
The keys are to look at the entire relationship, consider the degree or extent of the right to direct and control, and finally, to document each of the factors used in coming up with the determination.
If, after reviewing the three categories of evidence, it is still unclear whether a worker is an employee or an independent contractor, Form SS-8, Determination of Worker Status for Purposes of Federal Employment Taxes and Income Tax Withholding (PDF) can be filed with the IRS. The form may be filed by either the business or the worker. The IRS will review the facts and circumstances and officially determine the worker’s status.
Be aware that it can take at least six months to get a determination, but a business that continually hires the same types of workers to perform particular services may want to consider filing the Form SS-8 (PDF).
Employment Tax Obligations
Once a determination is made (whether by the business or by the IRS), the next step is filing the appropriate forms and paying the associated taxes.
Employment Tax Guidelines
There are specific employment tax guidelines that must be followed for certain industries.
- Employment Tax Guidelines: Classifying Certain Van Operators in the Moving Industry (PDF)
- Employment Tax Procedures: Classification of Workers within the Limousine Industry (PDF)
Misclassification of Employees as Subcontractors
Consequences of Treating an Employee as an Independent Contractor
If you classify an employee as an independent contractor and you have no reasonable basis for doing so, you may be held liable for employment taxes for that worker (the relief provisions, discussed below, will not apply). See Internal Revenue Code section 3509 for more information.
If you have a reasonable basis for not treating a worker as an employee, you may be relieved from having to pay employment taxes for that worker. To get this relief, you must file all required federal information returns on a basis consistent with your treatment of the worker. You (or your predecessor) must not have treated any worker holding a substantially similar position as an employee for any periods beginning after 1977. See Publication 1976, Section 530 Employment Tax Relief Requirements (PDF) for more information.
Misclassified Workers Can File Social Security Tax Form
Workers who believe they have been improperly classified as independent contractors by an employer can use Form 8919, Uncollected Social Security and Medicare Tax on Wages to figure and report the employee’s share of uncollected Social Security and Medicare taxes due on their compensation. See the full article Misclassified Workers to File New Social Security Tax Form for more information.
Voluntary Classification Settlement Program
The Voluntary Classification Settlement Program (VCSP) is a new optional program that provides taxpayers with an opportunity to reclassify their workers as employees for future tax periods for employment tax purposes with partial relief from federal employment taxes for eligible taxpayers that agree to prospectively treat their workers (or a class or group of workers) as employees. To participate in this new voluntary program, the taxpayer must meet certain eligibility requirements, apply to participate in the VCSP by filing Form 8952, Application for Voluntary Classification Settlement Program, and enter into a closing agreement with the IRS.
- Proper Worker Classification (Audio)
- Virtual Small Business Tax Workshop – Lesson 6
The Virtual Small Business Tax Workshop is composed of nine interactive lessons designed to help new small business owners learn their tax rights and responsibilities. See Lesson 6 for information on how to identify an employee versus an independent contractor.
- IRS Internal Training: Employee/Independent Contractor (PDF)
This manual provides you with the tools to make correct determinations of worker classifications. It discusses facts that may indicate the existence of an independent contractor or an employer-employee relationship. This training manual is a guide and is not legally binding.
- Form SS-8 (PDF)
- Publication 15-A (PDF) has detailed guidance including information for specific industries.
- Publication 15-B supplements Circular E (Pub. 15), Employer’s Tax Guide, and Publication 15-A, Employer’s Supplemental Tax Guide. It contains specialized and detailed information on the employment tax treatment of fringe benefits.
- Businesses with Employees
- Hiring Employees
- Know Who You’re Hiring – Independent Contractor (Self-employed) vs. Employee
Note: This page contains one or more references to the Internal Revenue Code (IRC), Treasury Regulations, court cases, or other official tax guidance. References to these legal authorities are included for the convenience of those who would like to read the technical reference material. To access the applicable IRC sections, Treasury Regulations, or other official tax guidance, visit theTax Code, Regulations, and Official Guidance page. To access any Tax Court case opinions issued after September 24, 1995, visit the Opinions Search page of the United States Tax Court.
Page Last Reviewed or Updated: 10-Jan-2013
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