Editorial · February 25, 2015
Independent Contractor or Employee: How to Tell
Independent contractor or employee status for federal taxes generally depends on who has the right to control how the work is done. The IRS sorts the facts into three groups: behavioral control, financial control and the type of relationship. No single fact decides it.
The answer shapes the business's tax duties. On an employee's wages, an employer must generally withhold federal income taxes. It must also generally withhold and pay Social Security and Medicare taxes, and pay unemployment tax. On payments to a contractor, an employer generally has no federal taxes to withhold or pay. The contractor's own earnings are subject to self-employment tax.
The core test: who has the right to control the work
If you have the right to control the work, the person doing it is generally your employee. That right covers both what will be done and how it will be done. Giving the worker freedom of action does not change that. A person is generally a contractor if you have the right to control only the result, and not how the work gets done.
Calling someone a contractor does not settle it. If an employer-employee relationship exists, what you call it makes no difference. Nor does it matter whether the worker is employed full time or part time.
No magic number of factors makes a worker an employee or a contractor. The IRS says to look at the entire relationship and consider how far the right to direct and control goes. It also says to write down each factor you used.
Behavioral control: who has the right to direct the work
Behavioral control asks whether the business has the right to direct and control how the worker does the task. The facts include the instructions and training the business gives.
An employee generally has to follow the business's instructions on when, where and how to work. Such instructions can cover the tools to use, the helpers to hire or use, where to buy supplies and what order to follow. A business may have enough behavioral control without instructions. That can happen if it has the right to control how the work results are achieved. The key question is whether the business still holds the right to control the details of the work.
A business may train an employee to do a job in a particular way. Contractors ordinarily rely on their own methods.
Financial control: who has the right to control the business side
Financial control asks whether the business has the right to control the business side of the worker's job. The IRS lists five kinds of facts, grouped here in three steps.
First, look at expenses and investment. Contractors are more likely than employees to have expenses that no one reimburses. Fixed costs that go on when no work is being done are especially important. A contractor often has a significant investment in the tools or facilities used. Even so, someone can be a contractor without a significant investment.
Next, look at the market. A contractor is generally free to look for business. Contractors often advertise and keep a visible business location.
Then look at pay and risk. A guaranteed regular wage for an hour, week or other period usually points to an employee. That holds even when commission is added. Contractors are often paid a flat fee for the job, or for time and materials. But in some professions, such as law, contractors are commonly paid by the hour. A contractor can make a profit or take a loss.
Type of relationship: how the job is set up
The third group looks at the type of relationship between the business and the worker. The IRS lists four kinds of facts.
One fact is a written contract that says what relationship the parties meant to create. Another is whether the business gives the worker employee-type benefits. Examples are insurance, a pension plan, vacation pay and sick pay.
How long the relationship is expected to last matters too. Say a business hires a worker expecting the relationship to last indefinitely, instead of for a specific project or period. The IRS generally treats that expectation as a sign the business meant to hire an employee. The fourth fact is whether the worker's services are a key part of the company's regular business. If so, the company is more likely to have the right to direct and control the work.
The IRS also gives industry examples. In one, it calls a licensed roofer an independent contractor. He has a signed flat-fee contract and carries business insurance under his company name. He hires his own roofers and must pay for repairs if the work has a problem. In another, the IRS calls an auto salesperson an employee. She works assigned days and times in the dealer's showroom. The dealer pays for her health insurance.
What to do when the answer is still unclear
If the three groups still leave you unsure, either side can file Form SS-8 with the IRS. After reviewing the facts and circumstances, the IRS officially decides the worker's status. That decision applies to federal employment taxes and income tax withholding. A decision can take six months or more. The form's Parts II, III and IV are headed Behavioral Control, Financial Control and Relationship of the Worker and Firm.
Treating an employee as a contractor can cost money. Without a reasonable basis, you may have to pay employment taxes for that worker. If you have a reasonable basis and meet other IRS conditions, you may get relief from those taxes.
The three-group test is not the whole story. Special rules can treat a few kinds of workers as employees for certain employment taxes. Under the federal minimum wage and overtime law, the Labor Department asks whether a worker is economically dependent on the business. The department says most workers are employees under that law. The department also says a signed agreement calling someone a contractor does not decide the worker's status. This is general information only. For a real worker, ask a tax adviser or an employment lawyer.