Independent Contractor or Employee?

By: Armand Rossi, CPA

Konowitz, Kahn & Co., P.C.

The shift by cost conscious employers toward using more independent contractors continues. The cost savings of treating a worker as an independent contractor instead of an employee are tremendous. It is not hard to see the appeal of these arrangements for businesses with employers taking advantage of such things as:

•  No tax withholding from wages

•  No payment for Social Security or Medicare

•  No job benefits

•  No contributions to unemployment insurance

However, if an employer misclassifies a worker as an independent contractor, it may result in back taxes and penalties.

The statement “once an employee, always an employee,” is not always the case. There is nothing in the law to prohibit a person from retiring and returning to work for an employer as an independent contractor. But, while there is nothing wrong with that, a determination has to be made as to whether the worker is actually an independent contractor in the new position. This area is commonly abused, and when an employer issues both a W-2 and a 1099 for the same person, the IRS is likely to take notice.

This quick overview of the criteria the IRS commonly uses in determining whether a worker is an independent contractor or an employee may help.

1..  Employees follow instructions about where, when and how to perform work.

2..  Employees receive wages on a schedule. Independent contractors are paid by project or on a commission.

3.  The employer usually reimburses any business or work-related travel expenses that employees incur.

4.  Employees generally work for one employer at a time. Independent contractors may work for several clients.

5.  Independent contractors offer their services to the general public whereas employees do not.

6.  Employees are required to work set hours. Independent contractors retain the right to complete their work at any time.

7.•  The services of employees are part of a continuing relationship with an employer whereas the independent contractor’s services are per project.

8.  Employees provide services that are part of the overall business operation and that require supervision and control by the employer. The work of independent contractor is generally not an integral part of the business’ operations.

9.  Most employers train their employees to ensure that the work meets certain standards. Independent contractors do not require training to adequately perform their work.

10.  Employees are required to render services personally while independent contractors can hire others to assist in the completion of the required work.

11.  Contractors may realize a profit or suffer a loss in performing their work, while employees do not.

12.  Employees do not invest in facilities that are used in carrying out their work.

13.  An employer-employee relationship usually requires that work be performed on the business’ premises.

14.  Employees receive the tools or equipment they need to complete work from their employer. Independent contractors furnish their own tools.

15.  Independent contractors can only be discharged for failure to perform the services they were hired to perform.

The key to all the factors is control. An independent contractor must be free of control regarding the means by which he completes his work. An employer has the right to demand certain specifications of the finished product, but the means by which it is completed should be left up to the contractor.

The penalties for misclassifying workers are steep, ranging from 1.5% of the wages paid to jail time for corporate officers. With these stakes, it may be wise to seek the professional advice of an accountant or attorney. Another option is for an employer to get a definitive ruling from the IRS as to a newly hired worker’s status as an employee or an independent contractor by completing Form SS-8, determination of Employee Work Status for Purposes of Federal Employment Taxes and Income Tax Withholding .