Congratulations! You are so busy in your new business endeavor that you have found yourself in a position to hire some additional help. Based on the circumstances, however, it may make sense for you to engage someone as an independent contractor instead of an employee. It is important to know the difference between these two designations because they have significance under the law.
An employee is someone on a regular payroll for whom you have control. If you have the right to control the details of how a person performs services, then that person is an employee. By contrast, an independent contractor has autonomy to determine what will be done and how it will be done. In such a relationship, the employer only has the right to control the result of the work and not how the work is completed.
In determining whether an individual is an employee or an independent contractor, it is important to look at the entire relationship. There are several aspects of the relationship to consider. First and foremost, determine whether the business has the right to control what the individual does in his or her job and how it is done. The greater control exerted by the business, the more likely it is that the individual is an employee. Another factor to assess is financial and whether the business provides certain tools and supplies or determines how certain expenses are reimbursed. An independent contractor will often manage these types of items independently of the hiring business. Lastly, it is important to look at the contracts between the parties. Merely stating in a contract that an individual is an independent contractor does not automatically make it true. If a contract offers certain employee benefits, for example health insurance or vacation pay, the individual begins to look more like an employee. The length of the relationship or the role of the individual and his or her importance to the running of the business may also matter in certain circumstances.
There is no straightforward answer to the status of an individual. If you remain uncertain as to whether an individual is an employee or an independent contractor, you can file Form SS-8, Determination of Worker Status for Purposes of Federal Employment Taxes and Income Tax Withholding, with the IRS. The IRS will review the facts and circumstances and officially determine the worker’s status.
So, you may ask, why does this matter? It is of great significance because employers owe employees a number of items under the law. The consequences for getting it wrong can result in the IRS or your state making a determination that you have employees and that you have therefore failed to comply with certain requirements, and will be subject to significant fines. For example, you must carry worker’s compensation insurance and pay certain taxes if you have employees. On the other hand, the earnings of a person who is working as an independent contractor are subject to Self-Employment Tax.