The issue of employees versus hiring people as independent contractors continues to be a bit of a gray area for employers, including tax implications. For small business owners the issue is particularly vexing because they run much thinner operating margins and use outsourced or temporary labor a lot more frequently to fill gaps.
A couple of items to follow can help any small business owner navigate the employee vs. contractor issue a bit better as follows below.
Make sure you categorize a worker similar to how the IRS would see the function. The IRS looks at three areas of employer control to figure how rules apply. They use behavioral control, financial control, and the type of relationship. Behavioral control is evidenced through top-down control; it looks at all the written direction and authority that is used by the employer to direct the worker to do his or her function. Financial Control points to who pays for the worker’s costs and labor. Type of relationship looks at how the work perceives the employer relationship.
Looking at the three areas above the IRS examines control of the worker, if the employer is dictating not just what function is to occur but how it should be produced, that leans toward an employee status versus an independent contractor. If on the other hand there is no control on the production side but just the final product (i.e. pay for satisfactory performance), then the worker leans more towards the independent contractor or outsourced side.
Mislabeling a worker as an independent contractor when he or she clearly is not can have serious ramifications. In a nutshell various employment taxes have not been collected in such instances, which when the mistake is found, are owed after the fact. This can include tax penalties as well.
Fortunately, small business owners do not have to guess in the dark. The IRS is willing to help with the evaluation process to better label workers. This can be done by filing an IRS Form SS-8 with the IRS for review. This form, the Determination of Worker Status for Purposes of Federal Employment Taxes and Income Tax Withholding, gets filled out by the employer and the IRS will produce a formal response which can then be kept on file by the employer for future questions or audits.
Alternatively, an employer can obtain information or review of a worker status directly through the IRS’ website by going to IRS.gov and going to the Small Business section. Via this Internet resource an employer can download Publication 15-A, Employer’s Supplemental Tax Guide, Publication 1779, Independent Contractor or Employee, and Publication 1976, Do You Qualify for Relief under Section 530. These documents and Form SS-8 can also be obtained by phone by calling the IRS at 800-829-3676 (800-TAX-FORM).