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Employees vs. Independent Contractors

employees vs contractorsEmployees vs contractors. A key decision facing every new business is how to hire people to do work for the business. Worker classification is an important legal distinction that determines payroll tax liability and the employer responsibility to pay for the worker’s expenses, tools/equipment and insurance.

The factors used by the IRS and the courts to decide if a worker is company employee or an independent contractor refer are summarized on one page in IRS Publication 1779 – Independent Contractor or Employee.

These key factors are considered by the IRS when making a determination:

employees vs sub contractors

Who are employees?
Common Law employee definition: Every individual who performs services subject to the will and control of an employer, as to what must be done and how it must be done, is an employee. It does not matter that the employer allows the individual discretion and freedom of action, so long as the employer has the legal right to control both the method and the results of the services.

Workers who are defined as Statutory employees:

  • A driver who delivers meat products, fruit products, beverages or delivers dry cleaning if the driver is the payer’s agent or is paid on commission.
  • A full time life insurance agent selling the policies of one life insurance company.
  • An individual who works at home on materials the payer supplies if the payer also furnishes specifications for the work to be done.
  • A full time salesperson who works on the payer’s behalf and turns in orders to the payer.

The goods sold must be merchandise for resale or supplies for the buyer’s business use.

Employers withhold income taxes and pay Social Security and Medicare taxes, and also unemployment taxes on wages paid to common-law employees and statutory employees.

DISCUSSION – Who are independent contractors?
Independent Contractor definition: Individuals such as lawyers, accountants, consultants, building trade contractors, public stenographers, etc., who follow an independent trade or business and offer their services to the general public. The general rule is that an individual is an independent contractor if the payer has the right to direct the result of the work but not the means by which that work is accomplished.

Example: Bob Smith, a plumber, submitted a job bid to a housing complex of $40 per hour for plumbing work that he estimates will take 500 hours. He will be paid $4,000 every two weeks for 10 weeks. This is not considered hourly payment. Even if he actually works more or less than 500 hours to complete the work, Bob Smith will only receive $20,000. He regularly performs plumbing work under contracts with other companies. Bob Smith is an independent contractor.

Statutory non-employee definition: An individual who receives payments for services that are directly related to sales or other output rather than the number of hours worked by that individual. Those services are performed under a written contract providing that the individual will not be treated as an employee for federal tax purposes.

Workers who are defined as statutory non-employees:

  • Direct sellers: Engaged in selling consumer products in the home or at a place of business other than a permanent retail establishment.
  • Licensed Real Estate Agents: Includes those individuals engaged in appraisal activities for real estate sales if they earn income based on sales or other output.

If you are in doubt about a worker’s definition, file form SS-8 with the IRS for a ruling.

Attached is a sample draft of an Independent Contractor Agreement, defining the responsibilities of the business and the independent contractor. Review this agreement with an attorney before using in your business.

We hope this gives you enough information to make the decision employees vs contractors. If you need more assistance your own free SCORE counselor can answer questions about how to best staff your business. Request yours here.

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