This is an excerpt from a presentation I give to entrepreneurs who are trying to get businesses off the ground.
One of the biggest areas of discussion when I give this presentation is over the subject of employees vs. independent contractors.
Let’s define some terms first: this discussion is about people you pay for work they do for your business. If someone is an employee, you pay them periodic wages. You withhold taxes from those wages, and your business owes payroll taxes.
Having employees is a big commitment.
If someone is an independent contractor, you simply pay them for the work they do. You don’t withhold taxes and you don’t owe payroll taxes.
Obviously, businesses like to classify as many people as possible as being contractors. Unfortunately, it’s not as simple as saying “this person is a contractor.”
How Do You Tell the Difference?
A few words of wisdom:
- You can’t just say someone is a contractor
- Having a signed agreement with the person, stating that they are a contractor, is not good enough
- It’s based on the facts and circumstances
- Control is the biggest factor
When we talk about control, there are 3 big factors to look at:
- Behavioral. Behavioral factors that lean towards a worker being an employee include: you control when the person comes to work, when they go to lunch and when they leave for the day. You provide the policies and procedures, the dress code, etc., and you supervise the work. A contractor can generally set their own hours, does the work according to the their own policies and procedures, and is often a person who provides a similar service to other businesses.
- Financial. Think of financial control this way: if someone is an employee, they’re probably using YOUR equipment, tools, etc. and if the equipment they’re using breaks, YOU are responsible for paying to fix or replace it. If someone is a contractor, they’re probably using their own equipment and tools, and THEY are responsible for replacing it if it breaks.
- Type/length of relationship. Earlier, I said a written contract saying someone is a contractor is not enough to establish that someone is in fact a contractor. However, a written contract could be evidence of a contractor relationship, in particular if the relationship is intended to be short-term. Remember, when you hire someone as an employee, you’re probably looking for a person who will show up every day. A contractor is typically someone who performs a particular task and then leaves.
There are other factors the IRS looks at when they audit this issue (and they DO audit it). This page on the IRS website gives more details.