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The tax law covering independent contractors is very complicated. Before
you can determine how to treat payments you make for services, you must
first know the business relationship that exists between you and the person
performing the services. The person performing the services may be -
- An independent contractor
- A common-law employee
(Employee)
- A statutory employee
- A statutory nonemployee
In determining whether the
person providing service is an employee or an independent contractor, all
information that provides evidence of the degree of control and
independence must be considered.
It is critical that you, the
employer, correctly determine whether the individuals providing services
are employees or independent contractors. Generally, you must withhold
income taxes, withhold and pay Social Security and Medicare taxes, and pay
unemployment tax on wages paid to an employee. You do not generally have to
withhold or pay any taxes on payments to independent contractors.
Caution: If
you incorrectly classify an employee as an independent contractor, you can
be held liable for employment taxes for that worker, plus a penalty.
Who is an Independent
Contractor?
A general rule is that you, the payer, have the right to control
or direct only the result of the work done by an independent
contractor, and not the means and methods of accomplishing the
result.
Example:
Steve Smith, a computer programmer, is laid off when Megabyte Inc.
downsizes. Megabyte agrees to pay Steve a flat amount to complete a
one-time project to create a certain product. It is not clear how long it
will take to complete the project, and Steve is not guaranteed any minimum
payment for the hours spent on the program. Megabyte provides Steve with no
instructions beyond the specification for the product itself. Steve and
Megabyte have a written contract, which provides that Steve is considered
to be an independent contractor, is required to pay Federal and state
taxes, and receives no benefits from Megabyte. Megabyte will file a Form 1099-MISC
(PDF). Steve does the work on a new high-end computer which cost him $7000.
Steve works at home and is not expected or allowed to attend meetings of
the software development group. Steve is an independent contractor.
Refer to the page on Paying Independent Contractor if
you need information on what your responsibilities are when paying
contractors.
Who is a Common-Law
Employees (Employee)?
Under common-law rules, anyone who performs services for you is your
employee is 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.
To determine whether an
individual is an employee or independent contractor under the common law,
the relationship of the worker and the business must be examined. All
evidence of control and independence must be considered. In an
employee-independent contractor determination, all information that
provides evidence of the degree of control and degree of independence must
be considered.
Facts that provide evidence of
the degree of control and independence fall into three categories:
behavioral control, financial control, and the type of relationship of the
parties. Refer to Publication 15-A, Employer's
Supplemental Tax Guide for additional information.
Who is an Employee?
A general rule is that anyone who performs services for you is your
employee if you can control what will be done and how it will be
done.
Example:
Donna Lee is a salesperson employed on a full-time basis by Bob Blue, an
auto dealer. She works 6 days a week, and is on duty in Bob's showroom on
certain assigned days and times. She appraises trade-ins, but her
appraisals are subject to the sales manager's approval. Lists of
prospective customers belong to the dealer. She has to develop leads and
report results to the sales manager. Because of her experience, she
requires only minimal assistance in closing and financing sales and in
other phases of her work. She is paid a commission and is eligible for
prizes and bonuses offered by Bob. Bob also pays the cost of health
insurance and group-term life insurance for Donna. Donna is an employee of
Bob Blue.
Statutory Employees
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 , below.
- A driver who distributes beverages
(other than milk) or meat, vegetable, fruit, or bakery products; or
who picks up and delivers laundry or dry cleaning, if the driver is
your agent or is paid on commission.
- A full-time life insurance
sales agent whose principal business activity is selling life
insurance or annuity contracts, or both, primarily for one life
insurance company.
- An individual who works at
home on materials or goods that you supply and that must be returned
to you or to a person you name, if you also furnish specifications for
the work to be done.
- A full-time traveling or
city salesperson who works on your behalf and turns in orders to you
from wholesalers, retailers, contractors, or operators of hotels,
restaurants, or other similar establishments. The goods sold must be
merchandise for resale or supplies for use in the buyer s business
operation. The work performed for you must be the salesperson s
principal business activity. Refer to the Salesperson
section located in Publication 15-A, Employer s Supplemental
Tax Guide for additional information.
Statutory Nonemployees
There are two categories of statutory nonemployees: direct
sellers and licensed real estate agents.
They are treated as self-employed for all Federal tax purposes, including
income and employment taxes, if:
1.
Substantially all payments for their services as direct
sellers or real estate agents are directly related to sales or other
output, rather than to the number of hours worked and
2.
Their services are performed under a written contract
providing that they will not be treated as employees for Federal tax
purposes.
Refer to information on Direct
Sellers located in Publication 15-A, Employer s
Supplemental Tax Guide for additional information.
Resources
- Tax Topic 762 Basic Information
To determine whether a worker is an independent contractor or an
employee, you must examine the relationship between the worker and the
business. All evidence of control and independence in this
relationship should be considered. The facts that provide this
evidence fall into three categories Behavioral Control, Financial
Control, and the Type of Relationship itself.
- Publication 1976, Section 530 Employment Tax
Relief Requirements (PDF)
Section 530 provides businesses with relief from Federal employment
tax obligations if certain requirements are met.
- IRS Internal Training:
Employee/Independent Contractor (PDF)
This manual provides you with the tools to make correct determinations
of worker classifications. It discusses facts that may indicate the
existence of an independent contractor or an employer-employee
relationship. This training manual is a guide and is not legally
binding. If you would like the IRS to make the determination of
worker status, please file IRS Form SS-8.
- Form SS-8 (PDF)
Determination of Worker Status for Purposes of Federal Employment
Taxes and Income Tax Withholding
- Publication 15-A
The Employer's Supplemental Tax Guide has detailed guidance
including information for specific industries.
- Publication 15-B
The Employer’s Tax Guide to Fringe Benefits supplements Circular E
(Pub. 15), Employer's Tax Guide, and Publication 15-A, Employer's
Supplemental Tax Guide. It contains specialized and detailed
information on the employment tax treatment of fringe benefits.
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