One of the graphic designers at Clayton’s company is about to go out on maternity leave. Clayton plans to hire an independent contractor to handle the extra workload while she’s gone.
Before Clayton goes any further, he has to be certain he understands how the IRS differentiates between independent contractors and employees. Otherwise, he could incur costly tax penalties. Generally, if Clayton directs only the result of the work, the worker is probably an independent contractor. However, if he directs the work and how it is done, the worker is probably an employee.
When determining whether a worker is an employee or an independent contractor, the IRS considers the extent of direction and control the company exercises. For example, the IRS might look at whether Clayton provides training and gives detailed instructions on how the work is to be done. Also important would be whether the worker pays business expenses without reimbursement and if he or she is in a position to realize a profit or incur a loss from the business relationship with Clayton’s company. And, if Clayton and his new worker have a written contract, the IRS may review it to determine both parties’ intentions.
The distinction between the two classifications is important for employment-tax reasons. Clayton 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 areas such as employee benefit plans and overtime pay.
An annual review of your worker classifications can help you avoid misclassifications and potential tax and penalty assessments.
Client Profile is based on a hypothetical situation. The solutions we discuss may or may not be appropriate for you.
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