Employee vs. contractor: The difference

employee-or-contractorAt some point in a small business’s life, every owner might need extra help producing deliverables and need to enlist additional workers to cover the extra load. If they classify those workers improperly, business owners could encounter significant IRS penalties.

The IRS has announced a major initiative to eradicate misclassifications of employees and contractors in 2016. Let’s look at the differences between each class.

Should I pay this worker as a 1099 contractor or a W2 employee?

Over the past decade, the IRS has developed guidelines and rules to help small business owners make the right choice between independent contractors and employees. Facts that provide evidence of the degree of control and independence fall into three categories:

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

The key is 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. 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.

Independent Contractor Defined

The general rule is that an individual is an independent contractor if the business 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. The earnings of a person who is working as an independent contractor are subject to Self-Employment Tax.

Employee Defined

Under common-law rules, anyone who performs services for a business is their employee. If the business can control what will be done and how it will be done, the worker is an employee. This is so even when the employee has freedom of action. What matters is the employer has the right to control the details of how services are performed.

If you have any questions and worker classifications or what penalties you could incur, contact our office at (405) 341-7044.