Employee vs. Independent Contractor Status

States and the IRS Look at Worker Status - So Should You as an Employer

How do you tell an employee from an independent contractor? It's often a difficult question, but it's one that has many serious implications. The IRS watches closely to make sure workers are classified correctly.

"The biggest trigger of IRS audits is mis-classifying employees as independent contractors," says Reva Lesonsky, of Yahoo Small Business.

Classifying Ride Sharing Drivers

Here's a recent example (from 2015) that explains the difficulty: California's Labor Commission said that an Uber driver should be classified as an employee, not an independent contractor, as Uber (the on-demand ride sharing company) claims. This ruling affected only one driver, and several other states have ruled that Uber drivers are contractors. Uber appealed the ruling and another similar one in Florida. 

More of these lawsuits, including some of the class action variety, are or will be headed to the courts soon. Note that it's not just the IRS, but states, that can make this determination. 

Are you certain your workers are correctly classified? 

The IRS considers a worker to be an employee unless independent contractor status is clearly indicated by the relationship.  The IRS evaluates every situation on a case-by-case basis. 

This article looks at the definitions of employee and independent contractor, explains the benefits and disadvantages of employee and independent contractor status for employers, and discusses how the IRS evaluates individual cases, 

What is an Employee?

employee independent contractor status
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An employee is a worker who performs services at the direction of an employer.  In general, anyone who performs services for an organization is an employee if the organization can control what will be done and how it will be done.

Examples of Independent Contractors and Employees

Tech Careers has some great examples to show you the difference between an independent contractor and an employee. Don't forget that each case is different, though, so be sure to check with your legal advisor before you make any assumptions about whether a worker is an independent contractor or an employee.

What is an Independent Contractor?

An independent contractor is an individual or business that provides services to another individual or business. The independent contractor is a separate business entity and is not considered an employee. Some examples of independent contractors are consultants, agents, or brokers.

How Employees and Independent Contractors Are Paid and Pay Reported

Employees are paid on an hourly or salaried basis, and they receive a W-2 showing their total earnings for the year. Independent contractors are paid by the job or by the hour, and they receive a 1099-MISC showing their total payments for the year.

NOTE: The way a worker gets paid is not a factor that the IRS uses to determine whether the worker is an independent contractor or an employee.

Independent Contractor or Employee - What is the Difference?

The IRS looks at three broad areas in making its determinations of whether a worker is an employee or contractor.  On a case-by-case basis, the IRS considers behavioral control, financial control, and relationship between the worker and employer.  Understanding these factors can help you in considering whether to hire an employee or a contractor.

IRS Test to Determine Worker Status

The IRS previously used a "20-factor test" to makes its determinations on worker status. The IRS used these factors as a guideline, not a checklist, and cases, as now, were decided on a case-by-case basis. While the test is no longer specifically used, it can be a guide for you in considering whether a workers is an employee or contractor.

Request an IRS Determination Using Form SS-8

You can request a determination letter from the IRS on the status of a worker, using Form SS-8. Getting a determination voluntarily can help you avoid fines and penalties for mis-classification of a worker.;

Advantages and Disadvantages of Hiring Employees vs. Contractors

When you start a new business, you will invariably decide that you need help. Most small business owners start out by hiring outside contractors to do work for them, but at some point you may decide to hire an employee or two. This article discusses the advantages and disadvantages of hiring employees vs. independent contractors.

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