Independent Contractors vs Employees

T A X A T I O N federal taxation

Classifying Independent Contractors and Employees

By Mary Recor

istinguishing between an independent contractor and an employee remains a complex, yet important, tax issue. Making the proper classification is crucial to both the party doing the hiring and the party providing the labor, especially in terms of tax payments and benefits. Employers that classify a worker as an employee are responsible for the employer’s portion of Federal Insurance Contributions Act (FICA) taxes. In addition, such employers bear the cost of federal and state unemployment taxes and of disability insurance; they must also provide employee benefits, including vacation pay and medical benefits. Accordingly, proper classification has been an ongoing battle between the IRS and taxpayers. Given the importance of proper classification, advisors and businesses should remain aware of developing standards in this area and of related court decisions. The discussion below provides an overview of these topics and offers best practices for avoiding penalties imposed by the IRS.

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Background In order to properly classify a worker, one must know the business relationship that exists between the individual providing services and the recipient of those services. As previously mentioned, the major areas affected by proper classification are payroll taxes and employee benefits, both of which generate costs for employers. An individual who performs services can fall into one of four classifications, according to IRS Publication 15-A, Employer’s Supplemental Tax Guide (http://www.irs.gov/pub/irs-pdf/p15a.pdf). Independent contractor. Professionals— such as doctors; lawyers; accountants; and others who offer services to the public as part of their independent trade, 48

business, or profession—are not necessarily employees; often, they are independent contractors. The general rule is that an individual is an independent contractor if the person for whom the...