Running and maintaining a business is a critical task. Although business owners attempt to do everything correctly with running their business, shortfalls may occur. One of the main tasks that business owners want to get correctly is the way that they classify their employees. There are a two ways that individuals can be classified. They can either be classified as independent contractors or employees. Independent contracts and employees are not the same. Knowing the distinction between the two will assist you in determining what your hiring strategy should be. It will also affect how you withhold several taxes.
It is imperative that you correctly determine whether the people providing services to your business are classified as employees or independent contractors. Generally, you must withhold income taxes, withhold and pay Social Security and Medicare taxes, and pay unemployment tax on the earnings that are paid to an employee. You do not generally have to withhold or pay any taxes on payments to independent contractors. Also, the amount of responsibility that you give a person and whether or not you control their duties is a factor as well.
How To Determine If Individuals Providing Services To You Are Employees Or Independent Contractors
Before you can determine how to pay for the services that are provided to you, you must first know the business relationship that exists between you and the person performing the services. The classifications are listed below:
Under common-law rules, anyone who performs services for you is your employee if you can control what will be done and how it will be done. This is so even when you give the employee freedom of action. What matters is that you have the right to control the details of how the services are performed.
The general rule is that an individual is an independent contractor if the payer has the right to control or direct only the result of the work and not what will be done and how it will be done. The earnings of a person who is working as an independent contractor are subject to Self-Employment Tax.
There are three categories of statutory non-employees: direct sellers, licensed real estate agents and certain companion sitters. Direct sellers and licensed real estate agents are treated as self-employed for all Federal tax purposes, including income and employment taxes. Read more
If workers are independent contractors under the common law rules, such workers may nevertheless be treated as employees by statute (statutory employees) for certain employment tax purposes if they fall within any one of the following four categories and meet the three conditions described under Social Security and Medicare taxes. Read more
The IRS uses three characteristics to determine the relationship between businesses and workers:
- Behavioral Control covers facts that show whether the business has a right to direct or control how the work is done through instructions, training or other means.
- Financial Control covers facts that show whether the business has a right to direct or control the financial and business aspects of the worker’s job.
- Type of Relationship factor relates to how the workers and the business owner perceive their relationship.
In determining whether the individual providing services to your company is an employee or an independent contractor, consider all of the information that provides evidence of the degree of control and independence that the person has. This will better assist you in making the determination. If your company is not ready to hire someone on full time, or you may just need a person for a short amount of time, consider hiring someone on a temporary basis.
Many small businesses relay on independent contractors for their staffing needs. There are several benefits to outsourcing individuals’ vs hiring employees. These benefits include:
- Savings on labor costs
- Flexibility to determine when you will hire or terminate someone without having them on your payroll
- Elimination of the taxes associated with having an employee
Regardless of your hiring needs, it is crucial that you correctly determine whether the people providing services to your business are classified as employees or independent contractors.