Business owners cannot do everything by themselves and eventually need to bring in some help. The question we then get asked the most is whether they should pay this person as an employee or a contractor. Business owners try just picking, which of course leads to contractor, because it’s cheaper. For contractors you don’t have to pay payroll taxes, have workers compensation, etc. Unfortunately, it’s not that easy. There is a time and a place, a rhyme and reason to picking employee vs. contractor. The problem is that if the IRS later determines you should have paid someone as an employee vs. a contractor, you would be liable for penalties , interest and the taxes.
There are actually four ways to classify a worker: a statutory employee, a statutory non-employee, a common-law employee or an independent contractor. The statutory employee and non-employee are less common, but still possible.
- Statutory employee – Someone who may qualify as an independent contractor but is treated as an employee for tax purposes such as life insurance sales people, traveling sales people, agent drivers.
- Statutory non-employee – Someone who may qualify as a common-law employee but is treated as self-employed such as real estate agent or companion sitter.
- Common-law employee – Someone who is treated as an employee, someone who receives a W-2 and has income tax and FICA withheld.
- Independent contractor – Someone who is self-employed and who is responsible for paying their only taxes, including FICA by paying estimated taxes.
There are three general rules to help classify a worker as a contractor or employee:
- Behavior – Employers typically would control when the work is completed, were the work is to be done and how the process is completed. Training is also provided to employees from employers. An independent contractor would complete the work/project at their own pace, where they’d like and usually do not require training.
- Financial – Employees are usually paid a regular wage and not on a per project basis. If supplies or other expenses are required, the contractor would typically incur those where an employee would have the employer pay for those expenses.
- Relationship – A contract is a great way to distinguish between a contractor or employee. The worker would receive either an independent contractor contract or have an employment agreement. Also, in many cases, benefits are provided to employees and not contractors.
This is a very quick overview of this complicated issue. If you are unsure how your workers should be classified, please do not hesitate to contact Bamboo Bookkeeping for a worker analysis. We can help you determine the classification and how to support that decision should it ever be questioned by the IRS.