Employee vs Contractor


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The federal government's interpritation of an employee versus a contractor is becoming more stringent. This article by Peter McDonald, CPA of Smith Elliott Kearns & Co., LLC explains several key questions which will help you understand the difference.

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Employee vs Contractor

  1. 1. Employee vs. Independent Contractor By Peter O. McDonald, CPAA critical part of business operations is determining whether an individual who is providing services to yourbusiness should be treated as an employee or an independent contractor. In general you must withhold andpay Social Security and Medicare taxes, withhold income taxes and pay unemployment taxes on wages paid toemployees. Usually you aren’t required to withhold or pay any taxes on payments to independent contractors.When determining whether your business relationship with an individual should be treated as an employee oran independent contractor, information regarding the degree of control and independence must be considered.The facts for each business relationship fall into three categories: Behavioral Control, Financial Control andType of Relationship.Behavioral ControlBehavioral control is used to determine if the business had retained the right to direct or control how theindividual does the work and is further broken down into the following factors:Types of Instruction Given When and where to work What tools or equipment to use What workers to hire or assist with the work Where to purchase supplies and services What work must be performed by a specified individual What order or sequence to follow when performing the workDegree of Instruction The more detailed the instructions, the more control the business retainsEvaluation System Evaluation systems that measure details of how the work is performed point towards an employeeTraining Training provided on how to do the job and periodic and on-going training about procedures and methods provide strong evidence of an employee relationship.Financial Control Financial control refers to the facts and circumstances whether a business has the right to control economic
  2. 2. aspects of the individual’s job. The factors of financial control fall into the following categories:Significant investment Varies by industryUnreimbursed expenses Independent contractors more likely to have unreimbursed expensesOpportunity of profit or loss The possibility of incurring a loss indicates independent contractorServices available to the market Independent contractor is usually free to seek other business opportunities, maintains a place of business, and advertisesMethod of payment Employee is usually guaranteed a regular wage, independent contractor usually paid a flat fee per jobType of RelationshipType of relationship denotes how the individual and business perceive their relationship with each other. Someof the factors to consider are the following:Written contracts - A contract is not sufficient to determine individuals’ status - The IRS does not always follow a contract stating the individual is an employee or independent contractor.Employee benefits A business generally does not provide benefits to independent contractorsPermanency of the relationship Is the relationship for an indefinite period of time or for a specified project or periodServices provided as key activity of the business Individuals who provide services that are a key aspect of the business are more likely to have their activities directed and controlled by the business which points toward an employee relationshipAll of the above factors must be considered when determining whether an individual is an employee orindependent contractor. Facts and circumstances will vary with each situation. The key is to look at the entirerelationship, consider the degree and extent of control and to document each of the above factors used incoming up with your determination.
  3. 3. If you are still unsure how to classify your business relationship with an individual, you can file Form SS-8 withthe IRS. The IRS will review the facts and circumstances of the business relationship and provide you with anofficial determination.Employees classified as independent contractors with no reasonable basis may cause the business to be liablefor employment taxes for the worker.Employers who believe they have misclassified workers may want to take advantage of a new optional programfrom the IRS called the Voluntary Classification Settlement Program. This program provides the opportunity toreclassify workers as employees for future tax periods for partial relief from employment taxes. Certainrequirements must be met in order to participate in the IRS program. Peter McDonald joined SEK&Co in 2000 and is a Manager in the Accounting Services Department of the Hagerstown, MD office. Previously, he gained accounting experience working as a Staff Accountant at Wilkinson and Company Chartered Accountants, Trenton, Ontario. Peter works with the firm’s small business and individual clients providing accounting, consulting and tax services. He also serves on the firm’s Accounting Services Committee. Smith Elliott Kearns & Company, LLC is a full-service certified public accountingand consulting firm with offices in Hagerstown, Maryland; Hanover, Carlisle, and Chambersburg,Pennsylvania. The firm was founded in 1963 and was recently named a Top 200 Firm by InsidePublic Accounting and a Pennsylvania Best Places to Work for 2010. With 22 partners and a totalstaff of 150, SEK&Co services individuals as well as business clients in a variety of industriesincluding construction, financial institutions, healthcare, local government, manufacturing, andnonprofit. The Firm offers financial statement preparation, auditing and assurance services, smallbusiness accounting, tax and payroll services, QuickBooks® and Sage 50® training and consulting,tax return preparation and planning, estate planning and administration, business valuations, andemployee benefit plan design, administration and auditing.