Independent Contractor

The Primary Tests for Employees vs. Independent Contractors

If the company controls and directs both what will be done and the details of how it will be done, then the worker is an employee. If the company controls only the final result of the work, but not how, when, and where the work is completed, then the worker is an independent contractor.

What matters when determining whether a person is an employee or not is if you have the right to control the details of how the services are performed, even if the employee is given leeway and freedom to complete the job (e.g. working from home).

The distinction is important because when a company hires an employee, it is required to match Social Security tax, Medicare tax, pay Federal and State Unemployment Tax, and withhold federal and state tax.

Independent contractors who are in business for themselves, on the other hand, are considered a separate business entity and are required to pay these taxes separately. An independent contractor does not receive a W-2 or fill out a W-4 for federal withholding. Instead, a contractor receives a 1099-MISC from the business for which services were performed. As a separate business entity, the contractor is then required to pay all taxes on the income reported on the 1099-MISC, including the employer portion Social Security and Medicare.

An independent contractor

• Owns a business and has significant investment in the business such as computers, software, office equipment, or specialized equipment.
• Can realize a profit and loss for projects done.
• Decides when, how, and where to work.
• Is not reimbursed for expenses by the client.
• Does not receive training or excessive instructions from the client or company.

An employee

• Reports to work at certain time and place.
• Follows detailed instructions on how to complete a project.
• Receives training and benefits from the company.

Companies sometimes hire contractors at discount prices to avoid paying taxes and benefits.

By calling an employee an independent contractor, companies could avoid paying taxes and benefits that substantially increase the cost of labor. But simply calling an employee an independent contractor can subject the employer to past penalties for all taxes due, in addition to requiring the employer to pay all federal withholding that should have been taken from the employee’s pay and paid to the IRS during the time. The penalties and interest added to the tax liability can be more than the original taxes due!

Independent contractors can also file an SS-8 with the IRS to determine whether or not they are really employees eligible to receive benefits.

From Independent Contractor vs. Employee back to the Small Business Payroll Home Page

Back to the Online Accounting and Small Business Accounting Home Page