It is critical that business owners correctly determine whether the individuals providing services are employees or independent contractors.
Generally, you must withhold income taxes, withhold and pay Social Security and Medicare taxes, and pay unemployment tax on wages paid to an employee. You do not generally have to withhold or pay any taxes on payments to independent contractors.
Select the Scenario that Applies to You:
- I am an independent contractor or in business for myself
If you are a business owner or contractor who provides services to other businesses, then you are generally considered self-employed. For more information on your tax obligations if you are self-employed (an independent contractor), see our Self-Employed Tax Center.
- I hire or contract with individuals to provide services to my business
If you are a business owner hiring or contracting with other individuals to provide services, you must determine whether the individuals providing services are employees or independent contractors. Follow the rest of this page to find out more about this topic and what your responsibilities are.
Before you can determine how to treat payments you make for services, you must first know the business relationship that exists between you and the person performing the services. The person performing the services may be –
In determining whether the person providing service is an employee or an independent contractor, all information that provides evidence of the degree of control and independence must be considered.
Common Law Rules
Facts that provide evidence of the degree of control and independence fall into three categories:
- 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 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?
Businesses must weigh all these factors when determining whether a worker is an employee or independent contractor. Some factors may indicate that the worker is an employee, while other factors indicate that the worker is an independent contractor. There is no “magic” or set number of factors that “makes” the worker an employee or an independent contractor, and no one factor stands alone in making this determination. Also, factors which are relevant in one situation may not be relevant in another.
The keys are to look at the entire relationship, consider the degree or extent of the right to direct and control, and finally, to document each of the factors used in coming up with the determination.
If, after reviewing the three categories of evidence, it is still unclear whether a worker is an employee or an independent contractor, Form SS-8, Determination of Worker Status for Purposes of Federal Employment Taxes and Income Tax Withholding (PDF) can be filed with the IRS. The form may be filed by either the business or the worker. The IRS will review the facts and circumstances and officially determine the worker’s status.
Be aware that it can take at least six months to get a determination, but a business that continually hires the same types of workers to perform particular services may want to consider filing the Form SS-8 (PDF).
Employment Tax Obligations
Once a determination is made (whether by the business or by the IRS), the next step is filing the appropriate forms and paying the associated taxes.
Employment Tax Guidelines
There are specific employment tax guidelines that must be followed for certain industries.
- Employment Tax Guidelines: Classifying Certain Van Operators in the Moving Industry (PDF)
- Employment Tax Procedures: Classification of Workers within the Limousine Industry (PDF)
Misclassification of Employees
Consequences of Treating an Employee as an Independent Contractor
If you classify an employee as an independent contractor and you have no reasonable basis for doing so, you may be held liable for employment taxes for that worker (the relief provisions, discussed below, will not apply). See Internal Revenue Code section 3509 for more information.
If you have a reasonable basis for not treating a worker as an employee, you may be relieved from having to pay employment taxes for that worker. To get this relief, you must file all required federal information returns on a basis consistent with your treatment of the worker. You (or your predecessor) must not have treated any worker holding a substantially similar position as an employee for any periods beginning after 1977. See Publication 1976, Section 530 Employment Tax Relief Requirements (PDF) for more information.
Misclassified Workers Can File Social Security Tax Form
Workers who believe they have been improperly classified as independent contractors by an employer can use Form 8919, Uncollected Social Security and Medicare Tax on Wages to figure and report the employee’s share of uncollected Social Security and Medicare taxes due on their compensation.
Voluntary Classification Settlement Program
The Voluntary Classification Settlement Program (VCSP) is an optional program that provides taxpayers with an opportunity to reclassify their workers as employees for future tax periods for employment tax purposes with partial relief from federal employment taxes for eligible taxpayers that agree to prospectively treat their workers (or a class or group of workers) as employees. To participate in this voluntary program, the taxpayer must meet certain eligibility requirements, apply to participate in the VCSP by filing Form 8952, Application for Voluntary Classification Settlement Program, and enter into a closing agreement with the IRS.
Independent Contractors Top 10 Frequently Asked Questions For many individuals, self-employment as an independent contractor can be a rewarding and satisfying career option. As is true with any employment relationship you enter, it’s important to understand the roles and responsibilities of everyone involved. Below are FAQs about independent contractor work to help you gain an understanding of what is involved. Q1. What would my employment status be as an independent contractor? A. There is a fundamental difference between being employed on a full-time regular basis by an employer and engaging in an independent contractor relationship. An employment relationship involves being placed on the employer’s payroll. Employees will be paid either a pre-determined amount (on an hourly or salaried basis), on a commission basis (which means earning income based on a sales-based schedule), or some combination of base pay and commission. All income earned is subject to federal, state, and local taxes, where applicable, and typically, the employer withholds those taxes from the employee’s paycheck. All income earned during the course of a calendar/tax year is reported to the employee and to the federal government by the employer on the form W-2. The employer determines the employee’s work methods and evaluates the employee’s performance. Independent contractors are self-employed. Independent contractors engage in a contracted agreement to provide services to a client in exchange for an agreed upon fee (lump sum, hourly, weekly, monthly, etc.), which may include some form of commission. Independent contractors are not placed on an employer’s payroll; instead, the independent contractor invoices the client for work performed and the client pays the independent contractor through Accounts Payable. The client does not withhold federal, state, and local taxes from the payment, and the independent contractor is responsible for satisfying all tax obligations. All income earned during the course of a calendar/tax year is reported to the independent contractor and to the federal government by the client on form 1099. The independent contractor is responsible to the employer for the end “product” but determines his/her own work methods. Most organizations are careful to distinguish independent contractors from employees. The federal government has adopted common law principles to determine an independent contractor relationship for federal income tax purposes. (Please refer to the checklist at the end, which can be used to assist in determining if someone is an employee or an independent contractor.) You should also be aware that courts in different jurisdictions may apply different tests for making the determination. Q2. Who might I work for as an independent contractor? A. Many businesses, large and small, engage the services of independent contractors. You’ll find that independent contractors work in a wide variety of industries, such as consumer products, transportation, technology, manufacturing, real estate, and so forth. Q3. How will I be paid? A. Reputable organizations typically disclose the terms and conditions of payment through a written compensation agreement. If commission is involved, the agreement should indicate whether the contractor is paid on a commission-only basis, draw vs. commission, or combination of base fee plus commission. The agreement will also describe how and when payment will be made. The terms of each applicable pay structure should be spelled out clearly in writing and agreed to by all parties before work is performed. The agreement should also clearly explain how payment disputes are settled. (Note: Remedies are available to independent contractors should a dispute involving payment for services arise. As independent contractors are self-employed, any dispute involving payment would be resolved either independently or with the help of dispute resolution services, such as collection services, mediation, or arbitration.) As with any agreement, you should seek advice and counsel from a trusted professional before signing and sign only when you fully understand what you are agreeing to. Q4. Are independent contractors eligible for benefits offered by an employer to its employees? A. No. Independent contractors are not eligible for benefits the client makes available to its employees. The independent contractor is self-employed and therefore responsible for his/her own benefits. Q5. Are there risks and responsibilities associated with being an independent contractor rather than an employee? A. Self-employment involves some risks and responsibilities that employees typically don’t assume. For example, the independent contactor assumes all responsibility for tax obligations, handles his/her own benefits, manages billing and collections; maintains appropriate licensing and insurance, and accepts legal responsibilities and exposure associated with performing the job. Q6. Am I protected by the same employment laws as an employee? A. In general, independent contractors are not protected by employment laws since they are self-employed. (The area of employment law is very complicated, and laws vary by state; questions about specific situations should be addressed to legal counsel.) For example, laws that provide for a safe work environment, free from health risks, harassment, or discrimination, protect the rights of employees but may exclude independent contractors. This underscore the critical importance of a written agreement that spells out how the relationship will function, what the expectations are on both sides, and how payment and work performance will be handled. Q7. What kind of investment might I be expected to make? A. Independent contractors who sell the products and/or services of a client will likely be required to first learn everything there is to know about the client’s product and/or services. This may involve an investment by the independent contractor both in time and expense. The time investment may include taking weeks or months to be trained in product knowledge, and this time may be without income. Some positions require independent contractors to purchase goods and/or services, which the contractor then sells to customers. (It is important to understand up front if unsold inventory can be returned after a specific period of time or if the independent contractor assumes the loss. This should be stipulated in the agreement.) The independent contractor may also be expected to incur other related expenses, such as securing licensing, where applicable. Q8. What if a customer is unhappy with the quality of my work or the products or services we are selling? A. The independent contractor is usually accountable for satisfying specific performance expectations, including delivering customer service. Your agreement as an independent contractor should clearly define how you should handle any customer-related complaints (e.g., returning defective products, doing a job over, and so forth.) Q9. What do I do if a client wants me to sign an agreement immediately? A. As with any agreement, if someone doesn’t want to give you adequate time to think it over or consult with others, you should take it as a warning. If it’s really a great deal, it will be available tomorrow. Give yourself at least 24 hours to think about the opportunity in relationship to your career goals and to discuss it with a trusted professional before you sign any documents. Q10. How can I tell if I am an “employee” or an “independent contractor”? Checklist “Employee” or “Independent Contractor” Employee or independent contractor? Below are examples of the questions the courts may review in making a determination. The most important consideration is that of control: Does the employer have the right to control or direct only the result of the work, and not the means and methods of accomplishing the result? If so, it is more likely that the worker will be considered an independent contractor. Thus, the following factors may be considered in determining whether the employer has sufficient control over the worker to result in employment status. Note that there are factors that are common to both “independent contractor” and “employee”; therefore, it is best to look at the relationship as a whole rather than focusing on one or two factors. The bottom line: The more the relationship looks like an employer/employee relationship, where the employer has the right to control the means and methods of accomplishing the desired results, the more likely it is that the courts will view it as such. • Is the worker required to follow specific instructions as to the means and manner of performing the work? (Yes=Employee; No=Independent Contractor) • Is there a set amount of hours and days that the person must work each week? (Yes=Employee; No=Independent Contractor) • Does the employer supply the office, equipment, and tools needed to accomplish the work? (Yes=Employee; No=Independent Contractor) • Must the work be performed on the employer’s premises? (Typically, a “yes” answer would indicate the person is an employee; however, there are instances where an independent contractor would be required to perform on the premises. You would need to consider your answer to this question in relation to everything else.) • Is the worker trained by the employer to perform the assignments? (Yes=Employee; No=Independent Contractor) • Is the assigned work a part of the regular business of the employer? (Yes=Employee; No=Independent Contractor) • How long does the relationship continue? (In general, the longer the relationship continues, the more the worker looks like an employee.) • Can the employer assign additional projects to the worker? (Yes=Employee; No=Independent Contractor) • Is the person paid in the same manner as employees, e.g., biweekly? (Again, typically a “yes” indicates the person is an employee, but there may be instances where the independent contractor is paid in the same or similar manner. Here again you will need to consider this factor in relation to all other factors.) • Can the worker hire assistants? (Yes=Independent Contractor; No=Employee) • Does the worker provide services to more than one firm? (Yes=Independent Contractor; No=Employee) • Does the worker make his or her service available to the general public? (Yes=Independent Contractor; No=Employee) • Is there a written contract between the parties delineating their rights and responsibilities? (Yes=Independent Contractor; No=Employee) • Can either the worker or the employer terminate the relationship at will? (Yes=Employee; No=Independent Contractor) • Is the worker making any investment into facilities or equipment, and will the person realize a profit or risk of loss? (Yes=Independent Contractor; No=Employee) The article was adapted by, the National Association of Colleges and Employment