Which is Which and Who is Who?

This question pops up more often than you would think. Between the Employment Development Department and the Internal Revenue Service, we think we’ve come with some answers for 10 common misconceptions about employees and independent contractors. But before we get on to those, here are a few “simple” definitions for you.

Who is an employee?

An employee includes all of the following:

• Any officer of a corporation
• Any worker who is an employee under the usual common law rules
• Any worker whose services are specifically covered by law

That’s crystal clear, isn’t it?

Who is not an employee?

Independent contractors are not employees. Independent contractors are engaged in separately established bona fide businesses. A bona fide business is subject to profit and loss. They usually contract to perform a specific task and have the right to control the way the task is to be accomplished. They have a substantial investment in their business and customarily perform services for more than one business.

Now that that’s cleared up, we can see where we get the following misconceptions…

1. Family members are not employees… On the contrary, hiring a family member to work for you as an employee can be a great tax planning strategy. In many cases, having family members as employees of a company are more common than having family members as independent contractors. An obvious example of having a family member as an independent contractor would be something like this: Assuming that your business is not a law firm, hiring your son the attorney to handle your bankruptcy.
2. If a worker earns less than $600 a year then the worker isn’t subject to payroll taxes… The $600 threshold only applies to whether or not you need to issue an IRS form 1099 MISC to an independent contractor. Before issuing that form, you need to determine if the worker is an employee or an independent contractor. Once that is determined, then the issue of payroll taxes or 1099’s is applied.
3. If I issue an IRS form 1099 MISC, then the worker is an independent contractor… If only that were the case. 1099-MISC forms are used by the IRS to track and report certain types of non-employment related income. When you provide a 1099-MISC form to a worker for payment of services, it does not automatically make them an independent contractor. There are other qualifications that must be met in determining the status of the worker.
4. Day laborers or casual laborers are not employees…There are many different types of employees under the law. Many people work part-time or as temporary help. Under the law, services commonly referred to as day labor, part-time help, casual labor, temporary help, probationary or outside labor are all employees.
5. My competitors treat their workers as independent contractors, why can’t I do the same… The days of “if he can, so can I…” ended back in grade school. The law defines employment relationships, not your competitors. If you misclassify your employees, it is you who will end up in hot water, dealing with unpaid payroll taxes, penalties, and interest, right next to your competitors.
6. My worker does similar work elsewhere. He must be an independent contractor… Just because your employee/worker does similar work at other locations does not automatically make him an independent contractor. There are other qualifications that the employee/worker must meet before he is qualified as an independent contractor. Quite simply, he could just have multiple part-time jobs in the same field.
7. My worker has a business license and business cards. Doesn’t that make him an independent contractor… While having those things certainly put him on the road to being an independent contractor, by themselves they do not. Other common law factors need to be met before your worker can be qualified as an independent contractor.
8. I only pay by commission, so I have no employees only independent contractors... How you pay your employees is not a factor in determining if your workers are employees or independent contractors. With employees, commissions are simply another form of wages.
9. I have a written contract with my worker, that makes him an independent contractor… A written contract does not automatically make your worker an independent contractor. How you actually work together in a relationship is more important than the working of a document in determining whether a worker is an employee or an independent contractor.
10. The right to control, whether or not exercised, is the most important factor in determining the relationship between an employer and employee. The right to discharge at will and without cause is strong evidence of the right to control.

While we mentioned several times the common law rules. The common law rules are intended to answer two questions: WHAT must be done, and HOW it must be done. If the person in control of these questions is YOU, your worker is an employee.

As you can see, this is not a black and white issue. There is no bright line test with a simple answer. Many factors play into determining the difference between an employee and an independent contractor. If we’ve raised more questions for you than provided answers, please contact us at Next Level Accounting and Tax. We will gladly answer any questions you have.