What is an Employee? 3 Ways to Help You Know
Employees vs. Independent Contractors
An employee is hired for a specific job or to provide labor and who works in the service of someone else (the employer). That definition sounds simple, but someone can do work for an employer and not be an employee.
What makes one person an employee and another person a non-employee? The work the two people do may be similar, but that doesn't make the distinction. How a person is paid has a relationship to the employee vs. non-employee classification, but pay comes after the distinction.
The IRS classifies a worker as an employee as follows:
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.
The factors designating someone as an employee include:
- A specific wage or salary
- An implied or written contract, and
- Control of the person's work by the employer.
Why It's Important to Know if Someone is an Employee
For tax purposes, it's important to know whether a worker is an employee. By "tax purposes," it means whether federal (and state) income taxes must be withheld from the person's pay and whether the employee and employer must pay FICA taxes (for Social Security and Medicare benefits). In these circumstances, the opposite of an employee is an independent contractor.
What is a Non-employee? What's the Opposite of an Employee?
A person may work for a business and not be an employee. In this case, the person is considered to be an independent contractor in relation to the other party, and he or she is self-employed. That is, the relationship between the two parties is between two businesses, one of which is providing a service to the other.
For example, if you work as a graphic designer for another company on a per-project basis or you and your team clean the offices of another company, you are considered to be an independent contractor, not an employee.
The 3 Criteria the IRS Uses to Define "Employee"
Expert Tip: Important:
Keep in mind that the IRS assumes that a worker is an employee unless you can prove otherwise. The burden of proof is on the employer.
The IRS uses three criteria to determine whether a worker is an employee:
- 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 the 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?
(If you click on the links in this quote, you can find out more about what the IRS says about each of these three criteria.)
Some State Agencies Define Employees More Strictly
Some states have stricter laws designating how workers are classified for the purposes of determining wage orders (wages, hours, and working conditions). They use variations of an ABC Test that restricts calling someone an independent contractor unless they meet specific criteria. California's ABC test includes these criteria, allowing someone to be classified as an independent contractor ONLY if they meet ALL THREE of these requirements:
- The worker is free from the control and direction of the employer. AND
- The worker performs work that is outside the usual course of the hiring entity's business, AND
- The worker is customarily engaged in an independently established trade, occupation, or business of the same nature as the work performed.
Other states have similar laws. If you have questions about how your state classifies independent contractors, check with the employment bureau or department.
Taxes for Employees vs. Independent Contractors
Whether you are an employee or an independent contractor, you must pay income taxes on all of your income, and you must pay for social security and Medicare taxes. But how these are paid and the amount differs between the two entities (employee vs. non-employee).
Taxes for an Employee: By law, an employee must have federal and state income taxes withheld from his or her pay. In addition, FICA taxes must be withheld from the employee's pay and the employer must also contribute to those taxes on behalf of the employee.
Taxes for an Independent Contractor: An independent contractor is not an employee, but is someone in a separate business from the hiring company. No income taxes are withheld from payments to an independent contractor (in most circumstances), and no FICA taxes are withheld from these payments nor are they due from the hiring company.
The issue, in a nutshell, is that some employers hire workers and call them "independent contractors" to avoid paying the FICA taxes on the worker's income.
But if a business hires workers and calls them independent contractors (a common occurrence), and the IRS or a state agency investigates or the workers complain, the business could be liable for back taxes and fines and penalties.
What if You Aren't Sure if a Worker is an Employee?
Each employment situation is different, and you may not be sure if your workers are employees or independent contractors. You can get a determination from the IRS by filing an SS-8 form. They will review all the relevant circumstances in the case and make the decision.