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Contractor or Employee?

Published on March 30, 2017

Your business is booming. You need to hire help. But should your new hire be an employee or an independent contractor?

Many businesses prefer to classify workers as independent contractors so they don't have to pay payroll taxes, provide benefits or be subject to labor laws such as overtime pay. Some workers, too, want to be classified as independent contractors so they don’t have payroll taxes deducted from each check (though they are still responsible for them), many of their business expenses are tax deductible, and they may have more flexibility in their working conditions.

Employment laws, however, restrict those choices even if both you and the worker agree. If you misclassify someone as an independent contractor when they should have been treated as an employee, the IRS will hit you hard with penalties and back taxes.

So let’s try to clear up a bit of confusion, although clarity is hard to find in the murky waters of defining employee status.

The primary issue the Internal Revenue Service uses to determine employee status is who “controls” the worker. The agency looks at three main areas:

1. Behavioral. Does the worker control how he or she does the work? Who determines when and where the employee works? Who controls the order or sequence of work processes?

2. Type of relationship. Is the work performed a critical and regular part of the business? How permanent is the relationship?

3. Financial. Does the worker have a significant investment? In other words, does he or she own their own work tools? Do they make their services available to others or do they work for other businesses?

In the decisions determining that workers should be considered employees rather than independent contractors, the issues seemed to come down to whether the work was essential to the business.

These issues are certain to need clarification in the next few years. As a business operator, you'd be wise to consult an attorney before hiring. For now, as you’re trying to decide whether to hire an employee or engage an independent contractor in your business, keep these points in mind:

Employees GENERALLY:

• Work at your location.

• Work hours specified by you.

• Work per your instructions.

• Use equipment provided by you.

• Are paid for their labor regardless of business performance.

• Work for you on a continuing basis.

• Are usually paid by unit of time (hourly, monthly).

• Can quit or be fired at any time.

 

Independent contractors GENERALLY:

• Are independent business people, especially if they are incorporated.

• Choose where and when they work.

• Control how they perform their services.

• Can earn a profit or suffer a loss.

• May manage multiple clients or customers.

• Work for you on an as-needed basis.

• Can be terminated or leave, according to the terms of their agreement with you.

 

Reviewed March 21, 2016