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Employee vs. Contractor Classification

It can get a bit tricky to know when to classify a worker as an employee or a contractor. The Internal Revenue Service says worker classification is critical, as it determines whether or not an employer has to withhold income taxes and pay Social Security, Medicare taxes and unemployment tax on any wages it pays out to an employee.

Businesses don’t usually have to withhold or pay any taxes on payments they make to independent contractors. Those earnings fall to the responsibility of the contractor as self-employment tax.  
In general, someone is an independent contractor if the payer (the person paying for the service) has the right to control or direct only the result of the work, not what and how it will be done. Businesses should treat these on a case by case basis and examine all facts presented in order to make the right designation.

A business may pay a contractor and an employee for similar work performed; however, there are vital legal differences between them. For the employee, the company takes out income tax, Social Security, and Medicare from any wages that are paid out. On the independent contractor side, the company doesn’t take out taxes. In addition, employment and labor laws don’t apply to contractors either.

How to Determine

To figure out if an individual should be classified as an employee or an independent contractor, the employer should first identify the degree of control it has when it comes to the relationship with the individual.

  • Does the company control what and how the worker does the job?
  • Does the company control the business aspects (how payment is made, if expenses are reimbursed, who provides supplies and tools) of the worker’s job? 
  • Is there a written contract regarding employee benefits, like insurance, a pension plan, or vacation pay?
  • Will the relationship continue after the initial work and is that work a crucial aspect of the business?

It’s not always cut and dried, though. Some factors could indicate that the worker is an employee, while others may show that the worker is an independent contractor. There is no “magic” number or set answer. One must look at the relationship as a whole, taking into account the degree or extent of the right to direct and control. If it’s still unclear after all that what the classification is, Form SS-8, Determination of Worker Status for Purposes of Federal Employment Taxes and Income Tax Withholding (PDF) can be filed with the IRS.

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