Understanding Employee vs.

Contractor Designation

FS-2017-09, July 20, 2017

The Internal Revenue Service reminds small businesses of the importance of

understanding and correctly applying the rules for classifying a worker as an

employee or an independent contractor. For federal employment tax purposes, a

business must examine the relationship between it and the worker. The IRS Small

Business and Self-Employed Tax Center on the IRS website offers helpful resources.

Worker classification is important because it determines if an employer must

withhold income taxes and pay Social Security, Medicare taxes and unemployment

tax on wages paid to an employee. Businesses normally do not have to withhold or

pay any taxes on payments to independent contractors. The earnings of a person

working as an independent contractor are subject to self-employment tax.

The general rule is that an individual is an independent contractor if the payer has

the right to control or direct only the result of the work, not what will be done and how it will be done. Small businesses should consider all evidence of the degree of control and independence in the employer/worker relationship. Whether

a worker is an independent contractor or employee depends on the facts in each

situation.

Help with Deciding

To better determine how to properly classify a worker, consider these three

categories – Behavioral Control, Financial Control and Relationship of the Parties.

Behavioral Control: A worker is an employee when the business has the right to

direct and control the work performed by the worker, even if that right is not

exercised. Behavioral control categories are:

Type of instructions given, such as when and where to work, what tools to use

or where to purchase supplies and services. Receiving the types of instructions

in these examples may indicate a worker is an employee.

Degree of instruction, more detailed instructions may indicate that the worker

is an employee. Less detailed instructions reflects less control, indicating that

the worker is more likely an independent contractor.

Evaluation systems to measure the details of how the work is done points to an

employee. Evaluation systems measuring just the end result point to either an

independent contractor or an employee.

Training a worker on how to do the job — or periodic or on-going training about

procedures and methods — is strong evidence that the worker is an employee.

Independent contractors ordinarily use their own methods.

Financial Control: Does the business have a right to direct or control the financial

and business aspects of the worker’s job? Consider:

Significant investment in the equipment the worker uses in working for

someone else.

Unreimbursed expenses, independent contractors are more likely to incur

unreimbursed expenses than employees.

Opportunity for profit or loss is often an indicator of an independent contractor.

Services available to the market. Independent contractors are generally free to

seek out business opportunities.

Method of payment. An employee is generally guaranteed a regular wage

amount for an hourly, weekly, or other period of time even when supplemented

by a commission. However, independent contractors are most often paid for the

job by a flat fee.

Relationship: The type of relationship depends upon how the worker and business

perceive their interaction with one another. This includes:

Written contracts which describe the relationship the parties intend to create.

Although a contract stating the worker is an employee or an independent

contractor is not sufficient to determine the worker’s status.

Benefits. Businesses providing employee-type benefits, such as insurance, a

pension plan, vacation pay or sick pay have employees. Businesses generally do

not grant these benefits to independent contractors.

The permanency of the relationship is important. An expectation that the

relationship will continue indefinitely, rather than for a specific project or

period, is generally seen as evidence that the intent was to create an employer-

employee relationship.

Services provided which are a key activity of the business. The extent to which

services performed by the worker are seen as a key aspect of the regular

business of the company.

Consequences of Misclassifying an Employee

Classifying an employee as an independent contractor with no reasonable basis for

doing so makes employers liable for employment taxes. Certain employers that can

provide a reasonable basis for not treating a worker as an employee may have the

opportunity to avoid paying employment taxes. See Publication 1976 PDF ,

Section 530, Employment Tax Relief Requirements for more information.

In addition, the Voluntary Classification Settlement Program (VCSP) offers certain

eligible businesses the option to reclassify their workers as employees with partial

relief from federal employment taxes.

The IRS can help employers determine the status of their workers by using Form

SS-8, Determination of Worker Status for Purposes of Federal Employment Taxes

and Income Tax Withholding. IRS Publication 15-A, Employer’s Supplemental Tax

Guide, is also an excellent resource.

Workers who believe an employer improperly classified them as independent

contractors can use Form 8919 to figure and report the employee’s share of

uncollected Social Security and Medicare taxes due on their compensation.

The IRS Small Business and Self-Employed Tax Center provides a multitude of

resources for small businesses as well as self-employed independent contractors.

Additional Resources:

Publication 15-A, Employer’s Supplemental Tax Guide

Form 1040-ES PDF , Estimated Tax for Individuals

Publication 505, Tax Withholding and Estimated Tax

Publication 535, Business Expenses

For information on eligibility for a voluntary program to reclassify workers as

employees with partial relief from federal employment taxes, visit Voluntary

Classification Settlement Program (VCSP).

Page Last Reviewed or Updated: 08-Jul-2020