How do I know if an individual performing work for my business is an employee or an independent contractor? This is an important question to ask each time you hire someone new to perform work for you and to answer before providing payment for services to him/her. The correct determination of employee or independent contractor is the responsibility of the business owner.
Why is this an important question? If determined to be an employee, the business owner is required to withhold from the employee’s pay federal income, Medicare and Social Security taxes. The business is also required to pay Medicare and Social Security taxes and Federal and State unemployment taxes on this person’s gross pay. The employer is required to obtain a completed W-4 from the individual at the point of hire to determine the proper federal income tax withholding. The business owner is required to issue an employee a W-2.
If determined to be an independent contractor, the business owner is required to obtain a completed W-9 from the individual/business. If the W-9 is incomplete or inaccurate (for example, the wrong taxpayer identification number is provided), the business owner is required to withhold 28% federal income tax, known as backup withholding. The business owner is required to issue an independent contractor a 1099.
Per Publication 15-A, 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.
Facts that provide evidence of the degree of control and independence fall into three categories:.
- Behavioral: Does the company control or have the right to control what the worker does and how the worker does his or her job?
- 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.)
- 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 business owner 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.