Updated: Oct 14, 2018
This blog is part two of the Organize Your Business Finances Series. Today we will focus on the differences between hiring an Employee versus an Independent contracted worker.
I often times find that small business owners are confused about the differences between an Independent Contract Worker and an Employee. The IRS pays close attention to this classification and making an error in this classification can cause you to have to pay retro payroll taxes, penalties and interest.
For small business owners it is much easier to classify a worker as an independent contractor rather than and employee eliminating the need to pay payroll and unemployment taxes. I see this a lot with small businesses that offer janitorial services. There are some specific distinctions between an Independent Contractor vs and Employee.
The IRS looks at three categories to determine if a worker is an employee or Independent contractor. Behavior, Financial and Relationship. Let’s take a closer look at each category.
1. Behavioral: Does the company control or have the right to control what the worker does and how the worker does his or her job? If yes, the worker in question would be classified as an Employee. Employees generally have to be trained to perform their job and they are expected to perform the job that they have been trained to do. They have to show up to work at a specified time and generally stop working at a specific time. The employer has the right to control the details of how the services are performed. An independent contractor can generally decide how they plan on completing an assigned job and they can choose anyone on their team to get the job done.
2. 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.) If yes, this worker would be classified as an employee. The payer would supply all the necessary supplies and equipment needed to perform the job. An Independent Contractor charges a fee for their services that may or may not be negotiable, and they generally provide all the supplies and equipment needed for getting the job done and are responsible for their own expenses.
3. 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? If yes, that worker is classified as an Employee. Generally, the job of the worker plays an important role in the success of the company and the worker only works for the payer and can be fired at any time. An Independent Contractor generally has multiple customers that they are servicing and are not exclusive to the payer. In addition, they are bound by a contract and generally are only let go if they are not meeting the terms of the contract or the payer can no longer meet the terms of the contract. In addition, Independent contractors have their own office space that is independent of the payer’s offices.
Deb Smith is a sales representative employed on a full-time basis by DNA Financial Services, a financial services company. She works 5 days a week, and works in the field during specified working hours. She make sales calls in order to bring new bookkeeping business into the company. New bookkeeping clients have to be approved by the owner. Lists of prospective clients belong to the company. Deb has to develop leads and report results to the owner. Based on Deb’s experience, she requires minimal assistance in closing sales and in other aspects of her work. Deb is paid a commission and is eligible for prizes and bonuses offered by DNA Financial Services. DNA also pays the cost of health insurance and group-term life insurance for Deb. Deb would be considered an employee of DNA Financial Services.
Independent Contractor Example
John Smith handles all IT related issues for DNA financial Services. John handles all updates to the website and network. John meets with the owner once a week to discuss any changes that need to be made to the website based on upcoming initiatives. The owner expresses when they would like the updates to be made and John checks his calendar to see if can honor the owners request because he has other customers that he service as well. Per the service agreement between John and DNA Financial John invoices for the services that he provides. John is an independent contractor of DNA Financial Services.
The key to determining if your worker is an employee or independent contractor is looking at the whole relationship in its entirety to see if the worker fits more into the category of an employee or an independent contractor. If you determine the worker is an employee you will be responsible for paying payroll and unemployment taxes for that employee.
If, after reviewing the three categories list above and you are still not certain whether a worker is an employee or an independent contractor, Form SS-8, Determination of Worker Status for Purposes of Federal Employment Taxes and Income Tax Withholding (PDF) can be filed with the IRS. The IRS will review the facts and circumstances and officially determine the worker’s status. This determination can take at least six months.
We do hope that this snapshot of the differences between employees versus independent contractors can aid your business. Remember, once you have analyzed your processes and run the numbers, make sure you choose wisely as to which one will work best for you.
Founded in 2015, DNA Financial Services LLC has pledged to Educate, Empower and Equip the financial DNA of its’ clients now and for generations to come. The company offers a number of financial services including tax preparation, bookkeeping, personal and business financial coaching. These services have been designed to bridge the gap in wealth building and functional money management, while promoting financial literacy for people from every walk of life.