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Independent Contractor Worker Classification:
Determination
Of Independent Contractor vs. Employee Worker Classification
It is critical that you, the employer, correctly determine
whether the individuals providing services are employees or
independent contractors. Generally, you must withhold income
taxes, withhold and pay Social Security and Medicare taxes,
and pay unemployment tax on wages paid to an employee. You
do not generally have to withhold or pay any taxes on payments
to independent contractors.
Before you can determine how to treat payments you make for
services, you must first know the business relationship that
exists between you and the person performing the services.
The person performing the services may be:
- An independent contractor
- A common-law employee
- A statutory employee
- A statutory nonemployee
Independent Contractors
People such as lawyers, contractors, subcontractors and auctioneers
who follow an independent trade, business, or profession in
which they offer their services to the public, are generally
not employees. However, whether such people are employees
or independent contractors depends on the facts in each case.
The general rule is that an individual is an independent contractor
if you, the person for whom the services are performed, have
the right to control or direct only the result of the work
and not the means and methods of accomplishing the result.
- Example: 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 that she obtained through
advertisements. Vera is an independent contractor.
Common-Law Employees
Under common-law rules, anyone who performs services for
you is your employee if you can control what will be done
and how it will be done. This is so even when you give the
employee freedom of action. What matters is that you have
the right to control the details of how the services are performed.
- Example: 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.
Statutory employees
If workers are independent contractors under the common law
rules, such workers may nevertheless be treated as employees
by statute (statutory employees) for certain employment tax
purposes if they fall within any one of the following four
categories and meet the three conditions described under Social
Security and Medicare taxes, below.
- A driver who distributes beverages (other than milk) or
meat, vegetable, fruit, or bakery products; or who picks
up and delivers laundry or dry cleaning, if the driver is
your agent or is paid on commission.
- A full-time life insurance sales agent whose principal
business activity is selling life insurance or annuity contracts,
or both, primarily for one life insurance company.
- An individual who works at home on materials or goods
that you supply and that must be returned to you or to a
person you name, if you also furnish specifications for
the work to be done.
- A full-time traveling or city salesperson who works on
your behalf and turns in orders to you from wholesalers,
retailers, contractors, or operators of hotels, restaurants,
or other similar establishments. The goods sold must be
merchandise for resale or supplies for use in the buyer's
business operation. The work performed for you must be the
salesperson's principal business activity.
Refer to the Salesperson section located in Publication
15-A, Employer's Supplemental Tax Guide (PDF)
for additional information.
Statutory Nonemployees
There are generally two categories of statutory nonemployees:
direct sellers and licensed real estate agents. They are treated
as self-employed for all Federal tax purposes, including income
and employment taxes, if:
- Substantially all payments for their services as direct
sellers or real estate agents are directly related to sales
or other output, rather than to the number of hours worked,
and
- Their services are performed under a written contract
providing that they will not be treated as employees for
Federal tax purposes.
- Refer to information on Direct Sellers located in
Publication 15-A, Employer's Supplemental Tax Guide
(PDF) for additional information.
- In determining whether the person providing service is
an employee or an independent contractor, all information
that provides evidence of the degree of control and independence
must be considered.
Social Security and Medicare Taxes:
Withhold Social Security and Medicare taxes from the wages
of statutory employees if all three of the following conditions
apply.
- The service contract states or implies that substantially
all the services are to be performed personally by them.
- They do not have a substantial investment in the equipment
and property used to perform the services (other than an
investment in transportation facilities).
- The services are performed on a continuing basis for
the same payer.
Employee Or Independent
Contractor?
An employer must generally withhold federal 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
Facts that provide evidence of the degree of control and
independence fall into three categories:
-
Behavioral: Does the company control or have the
right to control what the worker does and how the worker
does his or her job?
- Financial:
Are the business aspects of the worker's job controlled
by the payer? (these include things like how worker is paid,
whether expenses are reimbursed, who provides tools/supplies,
etc.)
-
Type of Relationship: Are there written contracts
or employee type benefits (i.e. pension plan, insurance,
vacation pay, etc.)? Will the relationship continue and
is the work performed a key aspect of the business?
Businesses must weigh all these factors when determining
whether a worker is an employee or independent contractor.
Some factors may indicate that the worker is an employee,
while other factors indicate that the worker is an independent
contractor. There is no "magic" or set number of factors that
"makes" the worker an employee or an independent contractor,
and no one factor stands alone in making this determination.
Also, factors which are relevant in one situation may not
be relevant in another.
The keys are to look at the entire relationship, consider
the degree or extent of the right to direct and control, and
finally, to document each of the factors used in coming up
with the determination. For
more detailed information on Common Law Rules.
Form SS-8
After reviewing the three categories of evidence, if you
are still unsure if a worker is an employee or an independent
contractor, the business can file Form
SS-8, Determination of Worker Status for Purposes of Federal
Employment Taxes and Income Tax Withholding (PDF)
with the IRS. The form may be filed by either the business
or the worker. The IRS will review the facts and circumstances
and officially determine the worker's status.
Be aware that it can take up to six months to get a determination,
but a business that continually hires the same types of workers
to perform particular services may want to consider filing
the Form Form
SS-8 (PDF).
Employment Tax Obligations
Once a determination is made (whether by the business or
by the IRS), the next step is filing the appropriate forms
and paying the associated taxes.
Misclassification of Employees
Consequences of Treating an Employee as an Independent
Contractor If you classify an employee as an independent
contractor and you have no reasonable basis for doing so,
you may be held liable for employment taxes for that worker
(the relief provisions, discussed below, will not apply).
See Internal Revenue Code section 3509 for more information.
Relief Provisions
If you have a reasonable basis for not treating a worker
as an employee, you may be relieved from having to pay employment
taxes for that worker. To get this relief, you must file all
required federal information returns on a basis consistent
with your treatment of the worker. You (or your predecessor)
must not have treated any worker holding a substantially similar
position as an employee for any periods beginning after 1977.
See Publication
1976, Section 530 Employment Tax Relief Requirements (PDF)
for more information.
Misclassified Workers Can File Social Security Tax Form
Workers who believe they have been improperly classified
as independent contractors by an employer can use Form
8919, Uncollected Social Security and Medicare Tax on Wages
to figure and report the employee's share of uncollected Social
Security and Medicare taxes due on their compensation. See
the full article Misclassified
Workers to File New Social Security Tax Form for
more information.
Distinguishing Between
Self-Employed Individuals and Independent Contractors
Self-Employed
You are self-employed if any of the following apply to you:
- You carry on a trade or business as a sole proprietor;
- You are a member of a partnership or limited liability
company that files a Form 1065, U.S. Return of Partnership,
that carries on a trade or business; or
- You are otherwise in business for yourself.
You are also self-employed if you have a part-time business,
in addition to your regular job.
Independent Contractor
The general rule is that an individual is an independent
contractor if (the person for whom the services are
performed) has the right to control or direct only the result
of the work, and not what will be done and how it will
be done or method of accomplishing the result.
People such as lawyers, contractors, subcontractors, public
stenographers, and auctioneers who follow an independent trade,
business, or profession in which they offer their services
to the public, are generally not employees. However, whether
such people are employees or independent contractors depends
on the facts in each case. The earnings of a person who is
working as an independent contractor are subject to Self-Employment
(SE) tax.
References/Related Topics
-
IRS Internal Training: Employee/Independent Contractor (PDF)
This 160 page manual provides you with the tools to make
correct determinations of worker classifications. It discusses
facts that may indicate the existence of an independent
contractor or an employer-employee relationship. This training
manual is a guide and is not legally binding.
Note: This page contains one or more references to
the Internal Revenue Code (IRC), Treasury Regulations, court
cases, or other official tax guidance. References to these
legal authorities are included for the convenience of those
who would like to read the technical reference material. To
access the applicable IRC sections, Treasury Regulations,
or other official tax guidance, visit the Tax
Code, Regulations, and Official Guidance page.
To access any Tax Court case opinions issued after September
24, 1995, visit the Opinions
Search page of the United States Tax Court.
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