The IRS distinguishes between an independent contractor and an employee. Basically, an independent contractor is an independent business person who runs his or her own business but who does work for another business. An employee is hired by a company to perform specific work at the direction of the employer.
The distinction between employees and independent contractors is important, because an employer must deduct Social Security/Medicare taxes from employees and must pay an equivalent amount to the Social Security Administration. If an individual is working as an independent contractor, the "employer" does not make Social Security/Medicare deductions, and the independent contractor must pay his or her own "self-employment taxes" along with income tax on earnings.
To help distinguish between employees and independent contractors, the IRS has set up three general criteria:
- Behavioral Control
If an employer trains and directs work, including hours of work, what tools or equipment to be used, specific tasks to be performed and how the work is to be done, the worker is likely an employee. If the worker can set his or her own hours and works with little or no direction or training, he or she is probably an independent contractor.
- Financial Control
This factor includes how the worker is paid, whether the worker may work for others at the same time, and whether the worker can incur a profit or loss. A worker who is paid a salary, is restricted from working for others, and who does not participate in company profits or losses, is probably an employee.
- Type of Relationship
The presence of a specific contract may indicate an independent contractor, but this factor alone is not controlling. If the worker is entitled to benefits, this would indicate an employment relationship. Another factor would be the type of work the person does; if it is directly related to the company's core work, he or she is probably an employee. For example, a maintenance worker would not be doing 'company' work if he or she were working for a bank.
It is important to note that the IRS assumes that a worker is an employee. It is sometimes difficult to determine the status of a worker. If you are unsure whether to classify a worker as an independent contractor or employee, you can file a Form SS-8 (PDF) to request a determination.See the IRS website for more details on the subject of independent contractors or employees.
Supreme Court Decisions Relating to Independent Contractor Status
The Department of Labor relies on Supreme Court decisions on independent contractors. These decisions reveal that there is no one single rule or test for independent contractor or employee for purposes of FLSA. The Court has held that it is the total activity or situation which controls. Among the factors considered significant are:
- The extent to which the services rendered are an integral part of the principal's business
- The permanency of the relationship
- The amount of the alleged contractor's investment in facilities and equipment
- The alleged contractor's opportunities for profit and loss
- The amount of initiative, judgment, or foresight in open market competition with other required for the success of the claimed independent contractor.
- The degree of independent business organization and operation.
- The place where work is performed
- the absence of a formal employment agreement
- whether the alleged independent contractor is licensed by the state/local government
- the time or mode of pay does not control the determination of employee status.
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