There appears to be an inclination on the part of businesses to want to categorize a person as an independent contractor rather than as an employee. The obvious reason is that the real independent contractor is not subject to all of the payroll taxes and insurance for worker's compensation that are required for employees.
The problem arises when an employer does not pay taxes on a person that is really an employee -- and the company is audited by the IRS. Then the taxes are due along with penalties and interest.
What is an "Employee"
The Internal Revenue code does not supply a definition of what an "employee" is but the regulations state that "generally the relationship of employer and employee exists when the person for whom the services are performed has the right to control and direct the individual who performs the services." Treasury Regulation Section 31.3401(c)-1(b).
A general rule of thumb that we have worked with in the past is that if the person is doing the type of work that the company normally does, the person is probably an employee. As an example, if the company normally builds mousetraps and the independent contractor is helping to build mousetraps, he will be considered an employee. But if the person is repairing the roof for the mousetrap company, he is probably an independent contractor.
The IRS has supplied its auditors with an IRS Manual which provides 20 criteria by which to determine whether a provider of services is an employee or an independent contractor. These points are only guidelines or indicators of the status but the IRS will apply them if the situation fits.
A synopsis of these twenty points are as follows:
1--INSTRUCTIONS--The ability to require compliance with time, place and manner of work normally indicates employee status.
2 --TRAINING-- Training of the person indicates employment. Normally, an independent contractors provides his own training.
3--INTEGRATION-- If the service provider is integrated into the business operation of the recipient, he will normally be considered an employee.
4--PERSONAL SERVICES-- If the services must be provided personally and cannot be delegated or sub-contracted, employee status is indicated.
5--HIRING & PAYING ASSISTANTS-- If assistants are hired and supervised by the company, the arrangement is normally considered to be employment.
6--CONTINUING RELATIONS-- A continuing and on-going relationship indicates an employee status.
7--SET WORK HOURS-- The recipients control of work hours and the consistency of those hours indicates employee status.
8--FULL TIME REQUIRED-- If the person is required to work full time and is not to work elsewhere, employee status is indicated.
9--WORK ON PREMISES-- Working on the company's own premises indicates employee status.
10--ORDER OF WORK The right of the employer to set the order in which work will be completed indicates employee status.
11--ORAL/WRITTEN REPORTS-- The right to require regular reports indicates employee status.
12--PAID BY HOUR, WEEK, ETC.-- Periodic payments based on normal employee payroll disbursement times indicates employee status. A fixed periodic payment along with other payroll is deadly.
13--BUSINESS or TRAVEL EXPENSE-- The payment of normal business, travel or supply costs normally indicates employee status.
14--TOOLS AND MATERIALS-- The furnishing of tools and materials by the employer to the person indicates an employee status.
15--SIGNIFICANT INVESTMENT-- If the provider of the services has a significant investment in his operation, it is an indication of an independent contractor. This requires that the investment be real, be essential and be adequate for the situation.
16--PROFIT OR LOSS-- If the provider can, by better management, make a profit or suffer a loss, it indicates independent contractor status.
17--MULTIPLE EMPLOYERS-- If the service provider works for multiple recipients at the same time, it indicates independent contractor status.
18--SERVICE TO GENERAL PUBLIC-- If the provider makes his services available to the general public, it indicates the status of independent contractor.
19--RIGHT TO FIRE-- The right to terminate the relationship at any time indicates employee status.
20--RIGHT TO QUIT-- The right of the provider to terminate the work without a current liability indicates employee status.
Remember, employees should receive a Form W-2 in January and the independent contractor should receive a Form 1099 but only if they have earned $600 or more during the year. No one should receive a W-2 and 1099 unless their status actually changed during the year.
For more information, refer to Publication 15-A (PDF),Employer's Supplemental Tax Guide, or Publication 1779 (PDF), Independent Contractor or Employee. If you want the IRS to determine whether a specific individual is an independent contractor or an employee, file Form SS-8 (PDF), Determination of Worker Status for Purposes of Federal Employment Taxes and Income Tax Withholding.