Distinguishing Between Employees & Independent Contractors

Quentin's company needs more IT support, but he isn't sure he has enough business to warrant the addition of another regular employee. He's thinking about hiring an independent contractor instead.

An independent contractor may be a good solution, but Quentin should proceed cautiously. To avoid costly tax penalties, he needs to make sure that the IRS would classify the new hire as an independent contractor and not as an employee. Generally, if he directs only the result of the work, the worker is probably an independent contractor. But if Quentin directs the work and how it is done, the worker is probably an employee.

The IRS considers factors in three categories to differentiate between the two classifications. The first category is behavioral control. The IRS would look at whether Quentin provides training and gives extensive instructions on how the work is to be done. The second category is financial control. Independent contractors may pay their own expenses without reimbursement and be in a position to realize a profit or incur a loss from business activity. The third category is the relationship of the parties. If Quentin and his new worker have a written contract, the IRS may review it to determine both parties' intentions.

Proper classification is important because Quentin is required to withhold and pay certain federal taxes on wages paid to employees but not on payments to independent contractors. Also, independent contractors are not subject to state and federal laws governing such things as employee benefit plans and overtime pay.

Incorrectly classifying workers can be costly to your business. Take the time now to review your worker classifications to avoid any tax penalties.

_{Client Profile is based on a hypothetical situation. The solutions we discuss may or may not be appropriate for you.}