The legal distinction between an employee and an independent contractor may seem like a subject suitable only for a law school exam, but it has real-life significance for both employers and employees.
Considering just federal taxes, for example, if a worker is an employee, the employer must withhold income tax and the employee’s part of Social Security and Medicare taxes. The employer also is responsible for paying Social Security, Medicare, and unemployment taxes on wages. An employee can deduct unreimbursed business expenses if the employee itemizes deductions and the expenses are more than 2% of the adjusted gross income.
If the worker has independent contractor status, however, there is no withholding, and the contractor is responsible for paying the income tax and self-employment tax. In that situation, it also may be necessary to make estimated tax payments during the year. An independent contractor can deduct business expenses, but on a different schedule of the tax return than is used by an employee.
So how do you tell the difference between an employee and an independent contractor? There is no single, quick answer. The particular facts of each case must be examined. However, relevant facts can be grouped into three general categories: behavioral control; financial control; and relationship of the parties.
The focus here is on who has the right to control how a worker does the work, rather than simply on the end result of the work. If a business has that right, the worker is an employee; if the worker retains that right, he is an independent contractor. The more that a worker gets instructions or training on how the work is to be done–such as determining what equipment to use, hiring assistants, or deciding where to get supplies–the more likely it is that the worker is an employee.
Apart from the actual performance of work, there is the question of a right to control the dollars-and-cents part of the work. Rather than having a direct financial stake in the business, an employee essentially works for a paycheck and maybe some reimbursed expenses. Some factors pointing more toward an independent contractor status include a worker’s significant investment in the work, his or her lack of a right to reimbursement of even high business expenses, and his or her potential to realize a profit or suffer a loss.
Relationship of the Parties
This factor considers how the parties themselves perceive their relationship. While an independent contractor, as the term suggests, is on his own concerning benefits, a worker who is provided insurance, retirement benefits, or paid leave is probably an employee. Sometimes the clearest picture of a worker’s status is to be found in a written contract. The parties’ intent, as shown in a contract, can be decisive, especially if the other factors do not lead to a conclusive answer.