How to Determine Whether the Individuals Providing Services are Employees or Independent Contractors
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.
What are the most important factors to consider?
Instructions to workers: Do you require the worker to follow instructions on how, when and where work is to be done?
Is job training provided: if training is provided for the worker, that is an indication that the job needs to be performed in a specific way and thus they would be considered an employee.
Does the worker have a financial stake: An employee will always be paid for the work done, whether it was done satisfactorily or not as they are paid based on time worked, but an independent contractor can realize a profit or incur a loss from his or her work and thus has a financial stake in the job.
These are some basic first questions that you can ask yourself in determining whether to classify someone as an employee or independent contractor.
You can also request a determination by filing a Form SS-8 “Determination of Employee Work Status for Purposes of Federal Employment Taxes and Income Tax Withholding”, but it is often cautioned that if the IRS cannot make a clear-cut determination, they generally classify the worker as an employee. Also, for those employers that do request a determination from the IRS, they will lose certain protections against liability for misclassification.
When making the determination, you will want to take into account two separate tests: The common law test (there are actually 20 factors that are used in the common law test and all can be found on the Form SS-8) and the reasonable basis test (in short, if you can show you had a reasonable basis for treating a worker as an independent contractor, the IRS is prohibited from reclassifying the worker as an employee either prospectively or retroactively).
When it comes to the 20- factor test, not all factors need to be in your favor to treat a worker as an independent contractor, but some factors do hold more weight than others, particularly the three factors discussed at the beginning of this article.
Many employers simply use the SS-8 as a way to make a determination judgement on their own and don’t actually submit the form to the IRS, this helps them to make an educated decision on how to classify a worker without having to get the IRS unnecessarily involved. You may want to consider using the form for self-auditing purposes to help you avoid steep misclassification penalties as the fees can be very costly.