Regardless of your field of employment, the classification of whether an individual is an independent contractor vs employee will determine which laws of the Internal Revenue Code and the Fair Labor Standard Act (FLSA) are applicable to your company and the people you work with. Understanding the factors that determine the definition of that relationship can help you avoid costly tax and legal issue.
In general, an employee is a person hired by a business to perform specific work at the direction and control of the employer. An independent contractor is an individual who owns his or her own business who does work for another business. The classification of an independent contractor versus an employee is dependent on the relationship that exists between the business and the person performing the services.
Within the court system, classification has not been determined by using a specific test or rule. Rather, rulings under the FLSA, which establishes labor laws regarding items like wages, overtime pay and recordkeeping, consider a totality of factors within the business relationship.
Business Relationship Factors for Determining Independent Contractor vs Employee Classifications
- Permanency of the relationship with employer;
- Extent to which the person’s services rendered are an integral part of the business;
- Relative investments in facilities and equipment by the business and worker;
- Nature and degree of control by the employer over the worker;
- Extent to which managerial skills of the worker may affect his or her opportunity for profit/loss for the work being performed for the company;
- Degree to which the worker has an independent business organization.
In determining whether an individual performing services for a business is an independent contractor or employee, the Internal Revenue Service (IRS) looks for information regarding three general criteria: Behavioral Control, Financial Control and Type of Relationship between the parties.
Behavioral Control – This criterion addresses the ability of the company to control the worker, looking at factors such as worker’s training, hours worked per work, specific direction regarding the work, and what tools and equipment are used. The more direction given and direct control taken by the company, the more likely the worker is an employee.
Financial Control – The opportunity of the worker to make a profit/loss not simply a wage, the investment by the worker in equipment and tools, and whether expenses are reimbursed by the company are determining factors within this criterion. The more financial control the company has the less likely the worker owns and manages his or her own business, and the more likely the worker will be deemed an employee.
Type of Relationship – Here, the IRS will look at whether there are written contracts between the parties, if benefits are provided to the worker, how permanent the relationship is and if the work is performed as part of the core aspects of the company. The more critical the work being performed, the longer the relationship and the payment of benefits all point to a worker being an employee.
The Internal Revenue Service strongly prefers that independent contractor-type business relationships be classified as employees. I believe this preference relates to the high non-filing rate of tax returns by independent contractors.
If a business relationship is deemed an employee relationship, employment taxes are automatically withheld and paid from the employee’s gross payroll. Both the employee and employer each pay their share of employment taxes, and the employee’s federal, state and local withholdings are paid to the respective taxing authorities.
The benefit to the employment relationship from the viewpoint of the IRS is that the vast majority of the employment and withholding taxes are remitted on behalf of both parties throughout the year by the employer’s payroll process.
After classification, if a worker is deemed an employee and his or her work is subject to FLSA, the employee must be paid at least the federal minimum wage as well as overtime for work in excess of 40 hours per week. The employee will also be subject to youth employment provisions, if a minor under 18 years of age.
The types of forms and filing requirements vary significantly for the worker and company depending on the classification. Our office will detail the form and timing of the filing requirements in our annual tax letter that will also be posted on our website.
The classification of a worker as an independent contractor or employee is case by case review and takes many factors into consideration. Please reach out to our office if assistance is needed with reviewing a classification issue, a ruling request with the IRS or seeking relief from penalties for an improper classification. You can email us at firstname.lastname@example.org or call 317-636-5561.