If you pay people to perform services for your business, it's important to classify them correctly. The IRS generally considers workers to be either independent contractors or employees, and the rules for taxes, reporting, and withholding are different for each.
Misclassifying a worker can lead to IRS penalties, unpaid employment taxes, interest charges, and other legal consequences. That's why understanding worker classification is a critical part of running a business.
Who Is an Independent Contractor?
According to the IRS, an individual is generally considered an independent contractor when the business controls only the final result of the work, not how the work is completed.
In other words, the worker typically has the freedom to decide:
- How the work is performed
- When the work is completed
- Which tools or equipment are used
- What schedule they work
Independent contractors are usually self-employed and are generally responsible for paying their own income taxes and self-employment taxes. Businesses typically report payments made to qualifying contractors on Form 1099-NEC. Common examples include freelancers, consultants, and other professionals who provide services to multiple clients.
Who Is an Employee?
A worker is generally considered an employee when the business has the right to control not only what work is performed, but also how it is performed.
Employees often:
- Receive training from the employer
- Use tools, equipment, or supplies provided by the employer
- Work a schedule set by the employer
- Follow established workplace policies and procedures
Employers are generally responsible for withholding income taxes, Social Security tax, and Medicare tax from employee wages. Employers may also be responsible for unemployment taxes and other employment-related obligations.
How Does the IRS Determine Worker Classification?
Worker classification isn't always straightforward. The IRS does not use a single test or checklist that automatically determines whether someone is an employee or an independent contractor.
Instead, the IRS reviews the overall relationship between the business and the worker. No single factor determines the outcome, and factors that matter in one situation may not be relevant in another.
The IRS generally evaluates three broad categories:
Behavioral Control
Does the business control how the work is performed, such as providing detailed instructions, training, or supervision?
Financial Control
Does the worker have control over business expenses, tools, investments, and the opportunity to earn a profit or incur a loss?
Relationship of the Parties
Are there written contracts, employee benefits, or other indicators showing the nature of the working relationship?
The IRS looks at the full picture when making a determination.
What If You're Not Sure How to Classify a Worker?
If you're unable to determine the correct classification, you can request assistance from the IRS by filing Form SS-8, Determination of Worker Status for Purposes of Federal Employment Taxes and Income Tax Withholding.
Form SS-8 asks for information about the worker, the services provided, and the working relationship. The IRS will review the details and make an official determination about whether the worker should be treated as an employee or an independent contractor.