Employees. Contractors. They both create and support products or provide services for your customers. They’re your company’s most valuable assets.
But the IRS looks at each very differently. And when you hire people and start dealing with their compensation, you, too, need to be very sure that you classify them correctly for income tax purposes.
You probably already know the primary difference between them. You only pay contractors or freelancers a fee for their contributions. With employees, you’re also responsible for employment taxes and often other benefits.
Control and Independence
The IRS itself states that “…there is no ‘magic’ or set number of factors that ‘makes’ the worker an employee or an independent contractor.” And you can’t use just one factor to make the determination. For example, you can’t call an individual an independent contractor simply because he or she works out of a home office instead of yours. Rather, you have to look closely at the whole relationship between your company and them. You need facts. You need to consider the “…degree of control and independence” involved, in three different categories.
Do you as the employer have the right to control how the individual works? There are four ways to measure here:
There are several questions to consider here. Does the individual:
Type of Relationship
As you can see, it’s more complicated than you might think. The IRS takes this issue very seriously, and has been known to follow up with companies where at least some of the classifications were suspected to be in error.