One of the most visited pages on the SmallBusiness.com WIKI is an entry on the topic of determining whether or not someone who is providing services to a company is an employee or an independent contractor. It’s a critical topic for both the business obtaining the services and the business (or sole proprietor) providing the services. Why? Because the way in which taxes are paid and certain benefits are allocated hinge on whether or not the provider is determined by the IRS and other federal and state agencies to be an employee or independent contractor.


Note: When it comes to issues related to taxes and the law, you should always consult your company’s legal and financial advisors before making a decision.


In many cases, it’s easy to know that a service provider is an independent contractor: You hire a freelancer to write copy for a brochure, you pay a bookkeeper to spend a few hours each month to assist on an accounting need, you hire a painter to repaint a room in your building. In those examples, it is easy to classify the service providers as independent contractors.

However, there are many situations in which determining the difference in employee and independent contractor status can become more confusing, and in some cases, contentious.

Why it’s critical to correctly determine whether a service provider is an employee or an independent contractor

Whether or not someone is an employee can have an impact on a wide array of federal, state and local regulations and taxes. Everything from tax withholding to employee benefits to wage and hour guidelines (minimum wage and overtime issues) are determined by the status of the relationship between the company and service provider. State and federal agencies have joined together to, in the words of the Department of Labor, “combat (the) pervasive issue” of employees misidentifying employees as independent contractors. Use of the word “combat” indicates that the Department of Labor views finding businesses misidentifying employees as a war. In such a war, it is important for a company to clearly determine its relationship to all those providing it services that may fall into a gray-zone.

Common law rules for determining the difference in an employee or an independent contractor

In general, there are three areas (or, “common law” rules) that determine if someone providing your company a service is an employee. All are related to how much control the business has over the provider.:

Behavioral factors: These factors relate to how much control the company has over what the worker does and how the worker does his or her job. For example, if the business hires a free lancer to provide a certain number of articles for a newsletter, that would be an independent contractor. If, on the other hand, the company required the freelancer to write those articles between 8 a.m. to 5 p.m. at a specific office using the company’s computer, the designation of independent contractor would be harder to defend.

Financial factors: Are the business aspects of the worker’s job controlled by the payer? These include things like how worker is paid, whether and how expenses are reimbursed, who provides tools/supplies, etc.

Relationship factors: Are there written contracts or employee type benefits (i.e. pension plan, insurance, vacation pay, etc.)? Will the relationship continue and is the work being performed a key aspect of the business? If it is, the relationship will more likely be judged a business-employee one.

According to the IRS, there is no “magic” or set number of factors that “makes” the worker an employee or an independent contractor, and no one factor stands alone in making this determination. Also, factors relevant in one situation may not be relevant in another. The keys are looking at the entire relationship, considering the degree or extent of the right to direct and control, and finally, documenting each of the factors used in coming up with the determination.

When in doubt, you can request a determination from the IRS

As noted above, you should never make decisions related to taxes or regulations without consultation with your legal and financial advisors. However, the IRS does provide the option to businesses to seek a ruling on an employee’s status by filing a Form SS-8 (PDF), “Determination of Worker Status for Purposes of Federal Employment Taxes and Income Tax Withholding.” The form may be filed by either the business or the worker. The IRS will review the facts and circumstances and officially determine the worker’s status.

Be aware that it can take at least six months to get a determination. And once a determination is made (whether by the business or by the IRS), the next step is filing the appropriate forms and paying any associated taxes the ruling may require.

Did we mention that you should seek guidance from your legal and financial advisors when doing this? Even if we did, it’s worth repeating.

Resources related to this topic:

Related Articles

25
Mid-Summer Tax Tips From the IRS: Review Your Withholding or Estimated Tax | 2017

Life events and changes in work may require a mid-year adjustment in tax withholding or estimated payments.

26
Seven Last-Minute Tax Filing Tips From the IRS | 2018

The first thing to remember: Don’t panic!

27
Is Tip Income Taxable? Here’s What the IRS Wants You to Know | 2017

The answer is yes and here are some resources the IRS provides to help you keep up with what you owe.

28
More U.S. Business Tax Resources and Statistics | 2017

Business-related statistics and statistical resources available from the U.S. Internal Revenue Service.

29
More Red Flags That Increase Your Odds of Being Audited by the IRS | 2017

More red flags that will cause the IRS to look closer at a tax return.

30
A Handy Calendar of Important Small Business Tax Dates | 2017

Bookmark this calendar of key IRS dates during 2017

31
Small Business IRS Tax Forms and Guide | 2017

The most up-to-date employer-related forms (as of 2.2017) from your friends at the IRS.

32
5 IRS Tax Facts for Self-Employed Small Business Owners | 2017

Information the IRS wants you to know.

33
Things The IRS Wants You to Know about Filing Late and Paying Penalties | 2016

Information about about filing your IRS return late and paying penalties

34
It’s Tax Day: What Are Your Chances of Being Audited? | 2016

The odds of you being audited depend on your income.

35
Five Things the IRS Wants You to Know About Filing a Tax Extension | 2016

While you can’t delay paying your taxes, here’s how to delay filing your return,

36
Home Office Tax Deduction Resources From the IRS | 2016

If you use part of your home for business, you may be able to deduct expenses for the business use of your home.

37
Owning a Small Business and 14 Other Red Flags Increasing The Odds You’ll be Audited

There’s no sure way to avoid an IRS audit, but here are things the IRS looks for in selecting returns they consider.

38
How to Keep From Overpaying Unemployment Insurance Taxes

Each year, many businesses pay more in unemployment insurance taxes than they should. Here is how to avoid being one of those companies.

39
How to Save Tax and Personal Financial Data Without Having Your Identity Stolen

The IRS recommends you keep tax forms and supporting documents a minimum of three years to a maximum of seven years.

40
How Much Tax You’ll Pay on Your $1.3 Billion Powerball Winnings

Before you start plans to expand your business, you may want to sit down with a team of your most trusted legal, tax and financial advisors.

41
A Dozen Business-Related Tax Incentives in the 2016 Budget, Spending Bill

The House of Representatives overwhelmingly passed the first of two bills that will avoid a government shut-down and make permanent a long list of tax provisions

42
A Small Business Year-end Tax Tip That Helps Throughout the Year

This tax calendar from the IRS that can be viewed online or via your computer or mobile device.

43
Six Tax Tips for Year-end Charitable Giving | 2015

Advice from the IRS about different types of year-end giving and how they can impact your taxes.

44
Small Business Tax Day Countdown: A New Taxpayer Bill of Rights

Adopted by the IRS in 2014, the Taxpayer Bill of Rights applies to all taxpayers, individuals or businesses, in their dealings with the IRS.

45
Small Business Tax Day Countdown: Good News, Bad News on How-to Find a Good Tax Preparer

How to find a good tax advisor and tax return preparer for your small business.

46
Affordable Care Act Tax Information From the IRS

The IRS provides a wide range of resources (all are published as PDFs) related to the Affordable Care Act and taxes.

47
Small Business Tax Day Countdown: Last Minute Tax Help You Can Find on the IRS.gov Website

Avoid long waits on-hold or in-line. The IRS.gov website has answers to many of your tax questions, printable tax forms and publications and more.

48
You Must Pay Taxes on Time, but Here are Ways to File an Extension for Turning in Your Tax Forms

Three ways to request an automatic extension of time to file your U.S. individual income tax return. (But your taxes are still due on time.)

49
Small Business Tax Day Countdown: While Tax Preparation is Rarely Free, Online Tax Filing Is

For small business owners and self-employed, the price at a free online tax filing service isn’t free. The price begins at $104.99 using TurboTax, for example.

50
Rollover Business Startups (ROBS) are Risky, May Violate Tax Laws

Use of a complex strategy to transfer IRA savings into funds to acquire a startup is not only risky, the IRS is challenging it.

51
New Ways States are Finding Small Business Tax Evaders

Following the IRS lead at the federal level, states are looking for ways to find small business owners and the self-employed who are evading state tax laws.

52
Tax-free Commuter (Even by Bicycle) & Parking Expenses

Even if your company does provide parking and commuting expenses as a benefit, they can be paid for with pre-tax money.

53
Add Up Your Healthcare Premiums With This ACA Tax Subsidy Calculator

The Kaiser Family Foundation created this calculator to illustrate health insurance premiums and subsidies for people purchasing insurance on their own in new health insurance exchanges