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Employee Vs. Contractor: What You Need to Know

When it is time to look for additional help in your business, it is important to determine what kind of worker you will be looking for.  Essentially, do you need to hire an employee or find an independent contractor.  But, how do you determine whether or not an individual should be classified as an employee of the business, or an independent contractor? According to the IRS – “The general rule is that an individual is an independent contractor if the payer has the right to control or direct only the result of the work and not what will be done and how it will be done. The earnings of a person who is working as an independent contractor are subject to Self-Employment Tax. You are not an independent contractor if you perform services that can be controlled by an employer (what will be done and how it will be done). This applies even if you are given freedom of action. What matters is that the employer has the legal right to control the details of how the services are performed.”
The IRS has three Common Law Rules:

  1. Behavioral: Does the company control or have the right to control what the worker does and how the worker does his or her job?
  2. Financial: Are the business aspects of the worker’s job controlled by the payer? (these include things like how worker is paid, whether expenses are reimbursed, who provides tools/supplies, etc.)
  3. Type of Relationship: Are there written contracts or employee type benefits (i.e. pension plan, insurance, vacation pay, etc.)? Will the relationship continue and is the work performed a key aspect of the business?

The keys are to look at the entire relationship, consider the degree or extent of the right to direct and control, and finally, to document each of the factors used in coming up with the determination.

The IRS has very stringent guidelines for classifying someone that performs work for your small business as an employee or a subcontractor. The IRS has Seven Tips for Business Owners You can find those tips here.

Cheryl Lynch is a consultant  at the FSBDC office in Putnam County. She has been the owner of several small businesses and has expertise in start-up ventures, financial and operational systems, human resources, marketing, mergers and acquisitions, sales, strategic planning, training and tactical execution.  Cheryl holds a CAM license and has a Bachelor’s Degree in Finance.

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