The difference between contractors vs. employees performing work or services for your business is more than just 1099s and W2s. In particular, define the role of your workers through two main distinctions…control and relationship. Let’s look at these two distinctions and how they shape your definition for the IRS.
Behavioral Control Over Workers
When an individual is an employee, the business has the right to tell them when and where to work and find the necessary tools to get the job done. When a person is an employee, providing them with detailed instructions is also a common practice. We define employee status by the extent to which evaluating and correcting the work methods occurs. Training, done on an ongoing basis, or one-time, is something that businesses typically do for employees.
When using a contractor, the business usually does not dictate the details of the work. When the company manages fewer details, the more likely the worker is a contractor. If the business is just interested in the final results, they are probably dealing with a contractor. Independent contractors will use their own methods and training. Companies do not have as much behavioral control over a contractor as they would over an employee.
Financial Control Over Workers – Contractors vs. Employees
Businesses have considerable financial control over employees. If the company invested in the equipment the worker is using, they are probably an employee. Employees are likely to be reimbursed for expenses that are related to the job. Employees usually work only for one company or business. An employee earns a regular wage, usually based on time or salary, and there is often a commission component attached to the job.
If a business hires a contractor to work for them, they usually have less financial control than they would have over an employee. Contractors typically invest in their tools or equipment necessary for the job. They make a profit or loss, depending on their efforts. They can sell their services to other businesses if so desired. Contractors earn a flat fee for a project or job.
Business Relationships With Contractors vs. Employees
If you pay for benefits for your workers, such as sick pay or health insurance, they are almost certainly employees. A contract stating what the relationship involves is not enough proof of status. If the connection is considered permanent, the IRS will view the worker as an employee. Employees perform work that is key to the regular business of the company.
A contractor does not receive benefits, such as vacation or 401k, as an employee does. You hire them for a specific job or project, or even a particular period. But, the relationship is not permanent.
What Happens if You Get it Wrong?
It’s not a good idea to classify employees as contractors unless they meet the control and relationship criteria detailed above. You might incur liability for employment taxes. You can avoid penalties through several government programs, but it’s better not to count on them. Classify your workers correctly, and don’t run the risk of being caught.
If You Need Help
If you need help determining what class your workers are in, reach out to us at JStevens Accounting, and let’s set up a meeting to help you settle the matter. We can help with W2s, 1099s, and tax preparation, in addition to year-round bookkeeping and accounting.