A Must Know for Businesses: Independent Contractor or Employee

The Department of Labor (DOL) and the Internal Revenue Service (IRS) are both increasing their enforcement efforts with random audits and imposing considerable financial penalties when they discover that a worker has been classified incorrectly.

It is crucial that business owners correctly determine whether the individuals providing services are employees or independent contractors.  In most cases, 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 normally have to withhold or pay any taxes on payments to independent contractors.

Getting it right the first time and avoiding unintended penalties will save you much time and money. Please see below for some helpful tips from the IRS website: (http://www.irs.gov/Businesses/Small-Businesses-&-Self-Employed/Independent-Contractor-Self-Employed-or-Employee)

Determining Whether the Individuals Providing Services are Employees or Independent Contractors
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
• An employee (common-law employee)
• A statutory employee
• A statutory non-employee

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:

1. Behavioral: Does the company control or have the right to control what the worker does and how the worker does his or her job?

2. 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.)

3. 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.

Form SS-8
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.

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.
• Forms and associated taxes for independent contractors
• Forms and associated taxes for employees

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
• Employment Tax Procedures: Classification of Workers within the Limousine Industry

As always, our government relations team is ready to help and answer any questions you may have. We also welcome your feedback!  Our contact information:  email: bbochniak@michbusiness.org or by phone: (888) 277-6464.