An employer must generally withhold income taxes, withhold and pay
social security and Medicare taxes, and pay unemployment tax on wages
paid to an employee. An employer does not generally have to withhold
or pay any taxes on payments to independent contractors.
Common-Law Rules
To determine whether an individual is an employee or an independent
contractor under the common law, the relationship of the worker and
the business must be examined. All evidence of control and
independence must be considered. In any employee-independent
contractor determination, all information that provides evidence of
the degree of control and the degree of independence must be
considered.
Facts that provide evidence of the degree of control and
independence fall into three categories: behavioral control, financial
control, and the type of relationship of the parties as shown below.
Behavioral control.
Facts that show whether the business has a right to direct and
control how the worker does the task for which the worker is hired
include the type and degree of--
Instructions the business gives the worker.
An employee is generally subject to the business' instructions
about when, where, and how to work. All of the following are examples
of types of instructions about how to do work:
- When and where to do the work
- What tools or equipment to use
- What workers to hire or to assist with the work
- Where to purchase supplies and services
- What work must be performed by a specified individual
- What order or sequence to follow
The amount of instruction needed varies among different jobs. Even
if no instructions are given, sufficient behavioral control may exist
if the employer has the right to control how the work results are
achieved. A business may lack the knowledge to instruct some highly
specialized professionals; in other cases, the task may require little
or no instruction. The key consideration is whether the business has
retained the right to control the details of a worker's performance or
instead has given up that right.
Training the business gives the worker.
An employee may be trained to perform services in a particular
manner. Independent contractors ordinarily use their own methods.
Financial control.
Facts that show whether the business has a right to control the
business aspects of the worker's job include:
The extent to which the worker has unreimbursed business
expenses.
Independent contractors are more likely to have unreimbursed
expenses than are employees. Fixed ongoing costs that are incurred
regardless of whether work is currently being performed are especially
important. However, employees may also incur unreimbursed expenses in
connection with the services they perform for their business.
The extent of the worker's investment.
An independent contractor often has a significant investment in the
facilities he or she uses in performing services for someone else.
However, a significant investment is not necessary for independent
contractor status.
The extent to which the worker makes services available to
the relevant market.
An independent contractor is generally free to seek out business
opportunities. Independent contractors often advertise, maintain a
visible business location, and are available to work in the relevant
market.
How the business pays the worker.
An employee is generally guaranteed a regular wage amount for an
hourly, weekly, or other period of time. This usually indicates that a
worker is an employee, even when the wage or salary is supplemented by
a commission. An independent contractor is usually paid by a flat fee
for the job. However, it is common in some professions, such as law,
to pay independent contractors hourly.
The extent to which the worker can realize a profit or loss.
An independent contractor can make a profit or loss.
Type of relationship.
Facts that show the parties' type of relationship include:
Written contracts describing the relationship the parties
intended to create.
Whether the business provides the worker with employee-type
benefits, such as insurance, a pension plan, vacation pay, or sick
pay.
The permanency of the relationship. If you engage a
worker with the expectation that the relationship will continue
indefinitely, rather than for a specific project or period, this is
generally considered evidence that your intent was to create an
employer-employee relationship.
The extent to which services performed by the worker are a key
aspect of the regular business of the company. If a worker
provides services that are a key aspect of your regular business
activity, it is more likely that you will have the right to direct and
control his or her activities. For example, if a law firm hires an
attorney, it is likely that it will present the attorney's work as its
own and would have the right to control or direct that work. This
would indicate an employer-employee relationship.
IRS help.
If you want the IRS to determine whether a worker is an employee,
file Form SS-8, Determination of Worker Status for Purposes
of Federal Employment Taxes and Income Tax Withholding, with the IRS.
Industry Examples
The following examples may help you properly classify your workers.
Building and Construction Industry
Example 1.
Jerry Jones has an agreement with Wilma White to supervise the
remodeling of her house. She did not advance funds to help him carry
on the work. She makes direct payments to the suppliers for all
necessary materials. She carries liability and workers' compensation
insurance covering Jerry and others he engaged to assist him. She pays
them an hourly rate and exercises almost constant supervision over the
work. Jerry is not free to transfer his assistants to other jobs. He
may not work on other jobs while working for Wilma. He assumes no
responsibility to complete the work and will incur no contractual
liability if he fails to do so. He and his assistants perform personal
services for hourly wages. They are employees of Wilma White.
Example 2.
Milton Manning, an experienced tilesetter, orally agreed with a
corporation to perform full-time services at construction sites. He
uses his own tools and performs services in the order designated by
the corporation and according to its specifications. The corporation
supplies all materials, makes frequent inspections of his work, pays
him on a piecework basis, and carries workers' compensation insurance
on him. He does not have a place of business or hold himself out to
perform similar services for others. Either party can end the services
at any time. Milton Manning is an employee of the corporation.
Example 3.
Wallace Black agreed with the Sawdust Co. to supply the
construction labor for a group of houses. The company agreed to pay
all construction costs. However, he supplies all the tools and
equipment. He performs personal services as a carpenter and mechanic
for an hourly wage. He also acts as superintendent and foreman and
engages other individuals to assist him. The company has the right to
select, approve, or discharge any helper. A company representative
makes frequent inspections of the construction site. When a house is
finished, Wallace is paid a certain percentage of its costs. He is not
responsible for faults, defects of construction, or wasteful
operation. At the end of each week, he presents the company with a
statement of the amount he has spent, including the payroll. The
company gives him a check for that amount from which he pays the
assistants, although he is not personally liable for their wages.
Wallace Black and his assistants are employees of the Sawdust Co.
Example 4.
Bill Plum contracted with Elm Corporation to complete the roofing
on a housing complex. A signed contract established a flat amount for
the services rendered by Bill Plum. Bill is a licensed roofer and
carries workers' compensation and liability insurance under the
business name, Plum Roofing. He hires his own roofers who are treated
as employees for Federal employment tax purposes. If there is a
problem with the roofing work, Plum Roofing is responsible for paying
for any repairs. Bill Plum, doing business as Plum Roofing, is an
independent contractor.
Example 5.
Vera Elm, an electrician, submitted a job estimate to a housing
complex for electrical work at $16 per hour for 400 hours. She is to
receive $1,280 every 2 weeks for the next 10 weeks. This is not
considered payment by the hour. Even if she works more or less than
400 hours to complete the work, Vera Elm will receive $6,400. She also
performs additional electrical installations under contracts with
other companies, which she obtained through advertisements. Vera is an
independent contractor.
Trucking Industry
Example.
Rose Trucking contracts to deliver material for Forest Inc. at $140
per ton. Rose Trucking is not paid for any articles that are not
delivered. At times, Jan Rose, who operates as Rose Trucking, may also
lease another truck and engage a driver to complete the contract. All
operating expenses, including insurance coverage, are paid by Jan
Rose. All equipment is owned or rented by Jan, and she is responsible
for all maintenance. None of the drivers are provided by Forest Inc.
Jan Rose, operating as Rose Trucking, is an independent contractor.
Computer Industry
Example.
Steve Smith, a computer programmer, is laid off when Megabyte Inc.
downsizes. Megabyte agrees to pay Steve a flat amount to complete a
one-time project to create a certain product. It is not clear how long
it will take to complete the project, and Steve is not guaranteed any
minimum payment for the hours spent on the program. Megabyte provides
Steve with no instructions beyond the specifications for the product
itself. Steve and Megabyte have a written contract, which provides
that Steve is considered to be an independent contractor, is required
to pay Federal and state taxes, and receives no benefits from
Megabyte. Megabyte will file a Form 1099-MISC. Steve does the work on
a new high-end computer which cost him $7,000. Steve works at home and
is not expected or allowed to attend meetings of the software
development group. Steve is an independent contractor.
Automobile Industry
Example 1.
Donna Lee is a salesperson employed on a full-time basis by Bob
Blue, an auto dealer. She works 6 days a week and is on duty in Bob's
showroom on certain assigned days and times. She appraises trade-ins,
but her appraisals are subject to the sales manager's approval. Lists
of prospective customers belong to the dealer. She has to develop
leads and report results to the sales manager. Because of her
experience, she requires only minimal assistance in closing and
financing sales and in other phases of her work. She is paid a
commission and is eligible for prizes and bonuses offered by Bob. Bob
also pays the cost of health insurance and group-term life insurance
for Donna. Donna is an employee of Bob Blue.
Example 2.
Sam Sparks performs auto repair services in the repair department
of an auto sales company. He works regular hours and is paid on a
percentage basis. He has no investment in the repair department. The
sales company supplies all facilities, repair parts, and supplies;
issues instructions on the amounts to be charged, parts to be used,
and the time for completion of each job; and checks all estimates and
repair orders. Sam is an employee of the sales company.
Example 3.
An auto sales agency furnishes space for Helen Bach to perform auto
repair services. She provides her own tools, equipment, and supplies.
She seeks out business from insurance adjusters and other individuals
and does all the body and paint work that comes to the agency. She
hires and discharges her own helpers, determines her own and her
helpers' working hours, quotes prices for repair work, makes all
necessary adjustments, assumes all losses from uncollectible accounts,
and receives, as compensation for her services, a large percentage of
the gross collections from the auto repair shop. Helen is an
independent contractor and the helpers are her employees.
Attorney
Example.
Donna Yuma is a sole practitioner who rents office space and pays
for the following items: telephone, computer, on-line legal research
linkup, fax machine, and photocopier. Donna buys office supplies and
pays bar dues and membership dues for three other professional
organizations. Donna has a part-time receptionist who also does the
bookkeeping. She pays the receptionist, withholds and pays Federal and
state employment taxes, and files a Form W-2 each year. For the past 2
years, Donna has had only three clients, corporations with which there
have been longstanding relationships. Donna charges the corporations
an hourly rate for her services, sending monthly bills detailing the
work performed for the prior month. The bills include charges for long
distance calls, on-line research time, fax charges, photocopies,
postage, and travel, costs for which the corporations have agreed to
reimburse her. Donna is an independent contractor.
Taxicab Driver
Example.
Tom Spruce rents a cab from Taft Cab Co. for $150 per day. He pays
the costs of maintaining and operating the cab. Tom Spruce keeps all
fares he receives from customers. Although he receives the benefit of
Taft's two-way radio communication equipment, dispatcher, and
advertising, these items benefit both Taft and Tom Spruce. Tom Spruce
is an independent contractor.
Salesperson
To determine whether salespersons are employees under the usual
common-law rules, you must evaluate each individual case. If a
salesperson who works for you does not meet the tests for a common-law
employee, discussed earlier, you do not have to withhold income tax
from his or her pay (see Statutory Employees earlier).
However, even if a salesperson is not an employee under the usual
common-law rules, his or her pay may still be subject to social
security, Medicare, and FUTA taxes. To determine whether a salesperson
is an employee for social security, Medicare, and FUTA tax purposes,
the salesperson must meet all eight elements of the
statutory employee test. A salesperson is an employee for social
security, Medicare, and FUTA tax purposes if he or she:
- Works full time for one person or company except, possibly,
for sideline sales activities on behalf of some other person,
- Sells on behalf of, and turns his or her orders over to, the
person or company for which he or she works,
- Sells to wholesalers, retailers, contractors, or operators
of hotels, restaurants, or similar establishments,
- Sells merchandise for resale, or supplies for use in the
customer's business,
- Agrees to do substantially all of this work
personally,
- Has no substantial investment in the facilities used to do
the work, other than in facilities for transportation,
- Maintains a continuing relationship with the person or
company for which he or she works, and
- Is not an employee under common-law rules.
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