Employee or Independent Contractor – How To Decide

Unfortunately, a business cannot just arbitrarily decide how to pay its workers.  Whether or not a worker is classified as an “employee” from whom taxes must be withheld by the employer or an “independent contractor” whom the employer pays his full pay is determined by IRS regulations.  As a general rule, the more control an employer has over the worker’s time and method of doing his job, the more likely it is that the IRS will call him an employee.

This becomes very important because if an employer pays his worker as in independent contractor and later the IRS finds him to be an employee, they will go back and charge the employer the payroll taxes that were not withheld plus penalties and interest.   There are several tests that must be met when making this determination, i.e. determining the amount of control the employer exerts:

(1) Behavioral control – does the employer have the right to direct and control how the worker performs his tasks;

(2) financial control – does the worker have the opportunity for a profit or loss, incur unreimbursed expenses or be able to work for others;

(3) the relationship of the parties – how do the parties perceive their relationship, as expressed in a written contract, availability of employee benefits, the right to terminate the relationship and the permanency of the relationship.

Although other factors can be introduced in particular cases, these are the primary ones that are examined.