Independent Contractor or Employee – Which Are You?

Independent Contractor or Employee - Which Are You? by Stephen J. Ganns, CPA{3:48 minutes to read} The IRS is becoming more and more strict about how employers categorize their workers, as to whether they are independent contractors or employees.

There are basically 3 areas that the IRS considers when deciding if a person is an employee or an independent contractor.

  1. The relationship of the parties:
    • Is there a written contract?
    • Does the contract spell out exactly what the employee or the independent contractor relationship is?
  2. Are there employee benefits?
    • If you receive benefits, such as insurance, pension or paid leave, that’s an indication that you may be an employee. However, if you do not receive benefits, that doesn’t automatically mean you’re not an employee. Perhaps the employer doesn’t offer benefits.
  3. Financial control:
    • Does the worker have a significant investment in their work?
      • Tools
      • Autos
      • Trucks
      • Machinery
    • Do they have to bring these to the place of employment in order to earn their income?
    • Do they get reimbursed for expenses? Most independent contractors do not get reimbursed for expenses, whereas employees usually do.

Is there an opportunity for profit or loss? An employee should never be in a situation where there’s an opportunity for profit or loss. An independent contractor may experience losses if the job does not go well, if they do not complete a job, etc.

In addition to the 3 categories above is behavioral control, determined by whether there is a right to control how a worker does the work.

Receiving expansive instructions on how the work is to be done suggests you are an employee. Instructions can cover a very wide range of topics, such as:

  • How, when, and where to do the work
  • What tools or equipment to use
  • Who provides the tools and equipment
  • Who hires assistants
  • Who determine where purchases or supplies and services will come from
  • Is training required

To use an accountant as an example, I am an independent contractor to all of my clients. I do not receive instructions on how the work is to be done or what software to use. I decide which software to purchase myself.

Independent contractor or employee?

It’s very important to know the distinction, especially if you are an employer. Many employers like to classify workers as independent contractors because it relieves them of having to provide benefits and payroll taxes. However, the IRS understands that there is a lot of fraud in this area, and if they determine that a person you classified as a contractor is really an employee, there are significant penalties, not to mention back withholding and payroll taxes that have to be paid.

If you are curious about how to classify employees, I suggest that you refer to Publication 1779 on the IRS website, speak to your tax preparer, or call us at 914-682-7007.

Stephen J. Ganns

Stephen J. Ganns, CPA
914-682-7007
steve@gannscpa.com
www.www.stephenjgannscpa.com

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