LUTZ BUSINESS INSIGHTS
independent contractor or employee? how to classify your workers
brandi mckay, client accounting services manager
When your small business hires a new worker, how do you decide whether that individual is an independent contractor or an employee? Independent contractors are, by definition, self-employed. They’re responsible for their own income taxes and benefits like health insurance. They can work part-time or full-time, and they usually take care of setting up their own office space.
But to the IRS, the distinction is not that simple. All of the above could apply to a worker, yet he or she might actually be an employee. The agency has been known to painstakingly scrutinize the relationships between management and labor at large companies in an effort to ensure that everyone has been classified correctly.
Unfortunately, there’s no magic formula you can apply to determine a worker’s status. Rather, the IRS defines the difference by asking you to explore three elements of employment that should help you make this distinction correctly. They are:
- Behavioral. Who controls what the workers do and how they do their jobs?
- Financial. What about the business aspects of the job? Who determines, for example, how workers are paid and whether expenses are reimbursed? Are workers responsible for their own office expenses, like tools and supplies?
- Type of relationship. Is management providing resources like written contracts and standard employee benefits? Is the individual providing work that is a “key aspect of the business?” Will the relationship be ongoing?
As you consider these questions, you may find that your answer to one would indicate that the worker is an independent contractor, while another points to an employer/employee relationship. There’s no one factor that determines what the worker’s status is. To muddy the waters further, some of the work that the individual does may lean in one direction, while other work would indicate a different answer.
Basically, it all comes down to the degree of control that management has over workers.
If you’ve answered these questions and are still unclear whether to classify people as employees or independent contractors, you or your workers can complete an IRS Form SS-8: Determination of Worker Status for Purposes of Federal Employment Taxes and Income Tax Withholding.
Individual states also have their own worker status “tests” based on workers’ compensation and unemployment insurance laws. This classification is actually more difficult in most states because you have to consider how economically dependent individuals are on the business, in addition to the degree of control tests. You can find contact information for your own state’s labor offices here.
As you may know, income taxes are handled very differently for independent contractors and employees. And it’s very important that you’re doing this right – for both you and your staff. If you have questions about this issue or about the classification of the individuals you employ, or if you’re looking for general business and accounting advisory services, please contact us.
ABOUT THE AUTHOR
BRANDI MCKAY + CLIENT ACCOUNTING SERVICES MANAGER
Brandi McKay is a Client Accounting Services Manager at Lutz with over seven years of experience in accounting. She is responsible for providing outsourced accounting services to clients with a focus in payroll compliance.
AREAS OF FOCUS
- Outsourced Accounting
- Tax & Payroll Compliance
- Healthcare Industry
AFFILIATIONS AND CREDENTIALS
- Medical Group Management Association, Past Member
- Nebraska Medical Group Management Association, Past Member
- MPA, University of Nebraska, Lincoln, NE
- BSBA in Accounting, University of Nebraska, Lincoln, NE
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