If you own a business, identifying those doing work for you as employees or independent contractors is important to government compliance. If you are a worker, knowing whether you are an employee or an independent contractor is essential to tax preparation.
Despite such an important classification for both workers and employers, many do not know what distinguishes one from the other.
Employee or an independent contractor?
As an employer, your concern lies in compliance. If someone is an employee of your business, you must withhold taxes, withhold and pay Social Security and Medicare taxes and pay unemployment tax on the wages paid to an employee. If the worker is an independent contractor, you generally do not have to comply with any of these regulations.
On the other hand, if you are working as an independent contractor, you are generally recognized as self-employed, and therefore are responsible for all the aforementioned withholding and payments yourself. Without an employer withholding taxes from each pay check, independent contractors often find themselves with a large sum owed when filing taxes.
So how do you know if you are employing or working as an employee or independent contractor?
Here are 20 questions (and answers) you should ask yourself:
A “true” independent contractor’s responses appear in parenthesis following each question.
- Are you required to comply with instructions about when, where and how the work is to be done? (No.)
- Does your client provide you with training to enable you to perform a job in a particular method or manner? (No.)
- Are the services you provide integrated into your client’s business operation? (No.)
- Must the services be rendered by you personally? (No.)
- Do you have the capability to hire, supervise, or pay assistants to help you in performing the services under contract? (Yes.)
- Is the relationship between you and the person or company you perform services for a continuing relationship? (No.)
- Who sets the hours of work? (You do.)
- Are you required to devote your full time to the person or company for which you perform services? (No.)
- Do you perform the work at the place of business of the potential employer? (No.)
- Who directs the order or sequence in which you work? (You do.)
- Are you required to provide regular written or oral reports to your client? (No.)
- What is the method of payment? Is it hourly, commission or by the job? (Fixed price, not-to-exceed, and/or milestone payments are standard for independent contractors.)
- Does the client reimburse your business and/or traveling expenses? (No.)
- Who furnishes tools and materials used in providing services? (You do. This includes workstation, internet, etc.)
- Do you have a significant investment in facilities used to perform services? (Yes. Key here is “significant.” Lots of employees have a home computer.)
- Can you realize both a profit and a loss from your work? (Yes, you must assume risk based on client satisfaction with your work. This is very important.)
- Can you work for a number of firms at the same time? (Yes.)
- Do you make your services available to the general public? (Yes. You should have business cards, stationery, invoices and a business listing in the phone book, for example.)
- Are you subject to dismissal for reasons other than nonperformance of contract specifications? (No.)
- Can you terminate your relationship without incurring a liability for failure to complete a job? (No. If you work on a project or milestone basis, you must deliver services to receive payment for your efforts.)
For more information on employees vs. independent contractors, visit the IRS website.
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