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Independent Contractor or Employee?

Independent contractor or employee

Independent contractor or employee?  This is an important question that small business owners need to get right.

Even if you are family owned and operated you will likely find the need to hire outside help to carry out business operations.

There are two ways to hire a person: as an independent contractor (paid with a 1099) or as an employee (paid with a W-2).

Did you know that the IRS or State can audit your worker classifications and reclassify your contractors as employees?

Many businesses fail to realize the differences and end up paying significant penalties for filing or classifying a position incorrectly!

What Defines an Employee?

Most often, when you hire someone to help out with your business, they will be hired as an employee.

This means that you are responsible for collecting payroll taxes and paying those taxes directly to the state and federal governments.  Failure to collect and pay these taxes can result in substantial fines.

Ignorance of the law is not an acceptable excuse!

Independent Contractors

The main difference between an employee and an independent contractor is that when you hire an independent contractor, you are essentially hiring someone that works for themselves.

You may contract out the services, but you are not directly responsible for collecting and paying taxes on the employees.  The tax burden in this case falls on the independent contractor.

Three Tests to Determine Classification

There are three primary considerations that an employer must consider when classifying a worker as an independent contractor or as an employee.

No single one of these factors can be used solely in order to determine the nature of the relationship and whether a worker is classified as an employee or independent contractor.

All of the factors must be examined together in order to make a correct determination.

1.  Schedule and Working

An employee will usually have a set schedule that is put in place by the employer.  When you hire a worker with the intention of setting their schedule and defining the individual tasks as well as how the work is performed, they should be classified as an employee.

Independent contractors are normally given a set task to complete and can choose how to go about completing that task in the time frame that is agreed upon.

If extensive on-the-job training is offered and mandatory, this is enough evidence to indicate that the worker is, indeed, an employee.

2.  Financial Matters

The way that a worker is paid also has a bearing on the status in which they are classified.

Employees are usually reimbursed for any expenses that they incur in doing their assigned tasks.  Independent contractors are normally paid a flat rate fee that is agreed upon where employees are paid an hourly rate.

This is not an exclusive indicator, however, as independent contractors can be paid an hourly rate in some professions.

3.  Relationship Status

The nature of the relationship between the owner and the worker is a determining factor in whether they are an employee or an independent contractor.

If benefits are present – this includes a pension plan, paid time off, and insurance – it will likely point to an employer-employee relationship.

However, it should be noted that the lack of these benefits does not indicate the existence of an independent contractor relationship.  Time is a significant matter as well – for example, is the job slated to end within a certain time frame or is it set to be on-going?

Independent contractors are usually bound by written contracts.  If the IRS cannot determine a worker’s status using other factors, the presence of a written contract may be the deciding factor.  The contract should identify the worker as an independent contractor and set out the terms accordingly.

Simply having a written contract is not enough to overrule the other factors!

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