They may look the same. They can even be doing the same job. Yet, according to the Internal Revenue Service how they work, when they work, and where they work distinguish them from each other. Independent contractors are not employees.
An employee meets certain requirements and has a set of rules to follow. The independent contractor performs with less control from the management and has independence in deciding his or her hours of work, place of work, work strategy, and work schedule.
An independent contractor works alongside the employees, and may even feel as part of the team. As a contractor, this worker can attend company picnics, conference meetings, and generally mix with the organization’s culture.
The IRS defines the differences between employees and contractors, and failing to recognize and adhere to these classifications results in substantial penalties.
The simplified version of employee v. contractor is that your organization needs to withhold payroll taxes such as income taxes, Medicare,and Social Security for an employee but not for an independent contractor. The contractor is responsible for withholding his or her own taxes.
With this in mind, there are different tax forms for employees and contractors. This means you will use a Form W-9 for employees and Form 1099-MISC for contractors to whom you paid $600 or more in a year.
IRS Rules
The IRS closely monitors and analyzes an organization’s classification of employees and contractors. To correctly comply with IRS rules, your organization must understand the relationship between the organization and the worker.
Knowing how to classify the contractor and employee is important because the individual must understand how to report his or her tax obligation. Knowing the status of your workers lets your organization know whether to withhold income taxes and pay Social Security, Medicare taxes and unemployment taxes on wages paid to an employee.
Your organization will not usually withhold taxes on payments you make to independent contractors. Independent contractors deal with receiving their earnings and following self-employment tax regulations.
Deciding
The basic rule for independent contractors is that an individual is an independent contractor if the payer has the right to direct and control the result of the work -- rather than how and what the employee will do.
To define the relationship with a worker, contemplate these classifications -- behavioral control, financial control, and relationships of the parties.
Behavioral Control: When your organization has the right to control and direct the work the worker does, the organization has control of the behavior of the worker -- he or she is an employee. Behavioral control categories are:
Instructions on where and when to work, what tools to use. Receiving these types of instructions show the worker is an employee.
Degree of instruction, detailed instructions are usually associated with an employee. Less control of the details shows less control and may indicate an independent contractor.
Evaluation methods that measure the specific features of how the work is done is characteristic of an employee relationship. Evaluation methodologies that consider only the end product can be for an employee or independent contractor.
Training a worker on how to do the job -- or occasional refresher training or ongoing training -- usually indicates an employee. Independent contractors are commonly responsible for obtaining their own training.
Financial Control: Consider whether the organization has the right to control the financial aspects of the worker’s job.
Financial investment in equipment the worker uses when working for your organization.
Unreimbursed expenses are more often required of independent contractors.
Services available to the community and not restricted only to your organization.
Method of payment. Your organization guarantees a certain amount of pay for hourly, weekly, or monthly services to employees. Independent contractors commonly receive a flat fee.
Relationship: The relationship between your organization and the worker is determined by the interaction with each other. This includes:
Written agreements that set forth the intended relationship. However, a contract stating a worker is an employee or independent contractor is not sufficient support to back-up an agreement if someone questions it.
Benefits. Your organization pays benefits to employees. These can be a pension plan, insurance, vacation pay, and sick leave. You organization does not pay these benefits to independent contractors.
How permanent the relationship is intended to be indicates the intention of the arrangement. A relationship expected to continue indefinitely is usually for an employee. Working together for a set time or project is confirmation of a contractor relationship.
Employees are considered key contributors to the activity of the organization. These services are essential to the viability of the organization.
This blog examines the differences between an employee and an independent contractor. When you have questions about preparing your IRS Form 1099, contact TBFoster Accounting to get your answers. We have ideas to share and solutions to management and organizational questions. Keep in touch with our blog. If you have questions about IRS Forms any other not-for-profit industry topics, contact our not-for-profit team leader at trent@tbfosteraccounting.com.
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