Do you know the difference between an employee and an independent contractor? Employers who misclassify their workers may have to pay the IRS additional tax plus steep penalties and interest when they get it wrong, whether this is intentional or not. In general, the IRS looks at three areas of control that an employer has over workers: behavioral, financial, and the type of relationship.
If an employer has the right to define how, when, and where a worker performs a task, and the particular equipment or software that must be used, that generally points to an employee relationship. Independent contractors, on the other hand, are generally free to use their judgement and apply the best means for accomplishing the task. Independent contractors are generally evaluated primarily on the quality of their work product, while employees may also be evaluated on how they do their work.
Employees may be restricted to one employer, which makes them financially dependent on that job. They are generally reimbursed for their out-of-pocket expenses, and the employer is typically the one who provides the tools and equipment for their work. However, some employees, especially those in the construction trades, make a considerable investment in tools, but this does not make them independent contractors.
Independent contractors are generally free to offer their services to other companies, and have the opportunity to make a profit or loss on their work. Typically, they are responsible for any tools, equipment, and specialized training needed for the work. Like employees, they may be reimbursed for their out-of-pocket expenses, but this depends on the agreement they have with their employer.
Type of Relationship:
Written contracts frequently specify the type of relationship that exists between a worker and an employer, but they may be ignored by the IRS if the situation suggests otherwise. The contracts of employees may be for a permanent or indefinite period of time, while those for independent contractors tend to specify a project or a specified period of time. Employees may be eligible for workplace benefits, while independent contractors generally do not. The main service offering of a company generally consists of the work done by employees, while independent contractors may provide only support services.
Misclassifying an employee as an independent contractor can also get you in trouble with the Department of Labor, so make sure you get this right. If you have any questions, please give our office a call!