It can sometimes be difficult to know whether a particular worker should be classified as an independent contractor or an employee for tax purposes, yet this can be a costly issue for both you and them.
Is your worker an employee?
Although there is no set definition of the term “employee,” the IRS has common-law rules regarding the matter. A worker is generally considered an employee if the company has the right to control and direct them regarding the job they must do and how they must do it. It’s also typical for an employee to be provided tools by their employer.
If your worker is an employee, the company must:
- Withhold income and payroll taxes from the employee’s paycheck,
- Pay the employer’s share of FICA taxes and Federal Unemployment Tax (FUTA),
- Provide the employee with any fringe benefits it provides to other employees, and
- Issue the employee a W-2 at the end of the year.
Is your worker an independent contractor?
According to the IRS, a worker is an independent contractor if the “payer has the right to control or direct only the result of the work and not what will be done and how it will be done”. . It can be very expensive for a person to be classified as an independent contractor, as payroll taxes generally total 15.3% of gross income plus any other expenses, such as purchasing health insurance on the open market.
If your worker is an independent contractor, the company must:
- Issue the contractor a 1099-MISC at year end.
There are some protections in place for companies that misclassify workers who would normally be considered employees and instead treat them as independent contractors, but these protections from employer tax liabilities are only applicable if you have a “reasonable basis” for not treating these workers as employees, if all similarly situated workers are also treated as independent contractors, and if all federal returns are consistent with this treatment.