Employee or Subcontractor?
It is critical that business owners correctly determine whether the individuals providing services are employees or independent contractors because the difference between the two can have a huge impact on your overall tax liability. 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.
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.
According to the IRS, the facts that provide evidence of the degree of control and independence fall into three categories:
Does the company control or have the right to control what the worker does and how the worker does his or her job?
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.)
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?
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).