Tax tip #5: Employees vs. contractors
February 01, 2016

What is the difference between an employee and an independent contractor? There's no concrete answer, but having an understanding of each reduces your workload during tax season. 

Wrongly classifying a person - saying they're an independent contractor when they're more accurately an employee, for example - has legal and financial consequences. You may be required to reimburse them for wages or pay back taxes for income, Social Security, Medicare and unemployment. You may also have to deal with any incorrect workers' compensation or employee benefits. It's much easier to understand the difference beforehand rather than to correct mistakes afterwards.

The IRS breaks down qualifications for employee versus contractor into three different categories: behavioral, financial, and type of relationship. Each of these has weight in determining a worker's status, but none make the final call. 

If the business has the right to direct, control or demand how the worker accomplishes a task, that worker is likely an employee. While this degree of control varies among industries, notably specialized ones like technology or medicine, employees are generally told when and where to do the job, who to work with and what equipment to use. Independent contractors are free to make these decisions for themselves.

A significant investment is sometimes - but not always - an indication that the person is self-employed. Independent contractors are also more likely to incur expenses a business won't refund. However, they are free to accept or reject jobs as they see fit. This freedom offers them a wide opportunity for profit or loss unavailable to standard employees.

Type of relationship
Finally, the relationship between your business and the worker in question helps define the latter's status. The IRS does consider any contracts between the two parties, but other factors ultimately hold more weight. A better indicator is if the worker was offered any benefits typical of employees, such as insurance, paid time off, sick days, disability and pension plans. Also, if there's no set date after which they stop working, the person in question is likely an employee. Contractors usually have a specific project or time period they work for, and they're free to help other businesses once they've finished with yours.

Again, none of these elements are singularly responsible for deciding if a person is an employee or self-employed contractor. However, it's good to reflect upon them so you don't incur any surprises when filing taxes.

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Nexus: G-WEBCD6