A key decision facing every new business is how to hire people to do work for the business. Worker classification is an important legal distinction that determines payroll tax liability and the employer responsibility to pay for the worker’s expenses, tools/equipment and insurance.

The factors used by the IRS and the courts to decide if a worker is company employee or an independent contractor refer are summarized on one page in IRS Publication 1779 - Independent Contractor or Employee.

These 20 key factors are considered by the IRS when making a determination:

An Employee: An Independent Contractor:
1. Must comply with Instructions 1. Decides on own work procedures
2. Is Trained to perform a certain way 2. Receives no training from the business
3. Is Integrated into the organization 3. Performance creates a unique reputation
4. Renders Services personally 4. Can use someone else to do the work
5. Hires and Supervises assistants at the Employer's direction 5. Hires own assistants
6. Has a Continuing Relationship 6. Relationship ends at the end of the job
7. Employer Sets Hours of Work 7. Master of own time
8. Normally a Full-Time Commitment 8. Chooses when to work
9. Works on premises 9. Can work off-premises if appropriate
10. Work sequence set by employer 10. Can set own sequence of work
11. Submits reports to employer 11. Periodic reporting is a negotiated item
12. Paid by hour, week, bi-week 12. Paid by job or by an hourly fee
13. Employer pays travel/expenses 13. Paid based on the terms of the job
14./15. Equipment and facilities furnished by employer 14./15. Furnishes own equipment
16. Is insulated from Profit or Loss 16. Provides key production equipment
17. Can work for several firms or people 17. Works freely for other firms, not controlled by the firms
18. Does not work directly for the public 18. Seeks opportunities from the public
19. Can be discharged at will 19. If work as-specified, no right to discharge
20. Can quit without incurring liability 20. Responsible to complete job satisfactorily

Employers withhold income taxes and pay Social Security and Medicare taxes, and also unemployment taxes on wages paid to common-law employees and statutory employees.

DISCUSSION – Who are independent contractors?

Independent Contractor definition: Individuals such as lawyers, accountants, consultants, building trade contractors, public stenographers, etc., who follow an independent trade or business and offer their services to the general public. The general rule is that an individual is an independent contractor if the payer has the right to direct the result of the work but not the means by which that work is accomplished.

Example: Bob Smith, a plumber, submitted a job bid to a housing complex of $40 per hour for plumbing work that he estimates will take 500 hours. He will be paid $4,000 every two weeks for 10 weeks. This is not considered hourly payment. Even if he actually works more or less than 500 hours to complete the work, Bob Smith will only receive $20,000. He regularly performs plumbing work under contracts with other companies. Bob Smith is an independent contractor.

Statutory non-employee definition: An individual who receives payments for services that are directly related to sales or other output rather than the number of hours worked by that individual. Those services are performed under a written contract providing that the individual will not be treated as an employee for federal tax purposes.

Workers who are defined as statutory non-employees:

  • Direct sellers: Engaged in selling consumer products in the home or at a place of business other than a permanent retail establishment.
  • Licensed Real Estate Agents: Includes those individuals engaged in appraisal activities for real estate sales if they earn income based on sales or other output.

If you are in doubt about a worker’s definition, file form SS-8 with the IRS for a ruling.

Attached is a sample draft of an Independent Contractor Agreement, defining the responsibilities of the business and the independent contractor. Review this agreement with an attorney before using in your business..

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Disclaimer

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INDEPENDENT CONTRACTOR AGREEMENT

(1) As an Independent Contractor, I agree that:

  1. I have a significant investment in my own assets or training
  2. I will perform the contracted services for a specified period of time, an agreed-upon number of hours or until a specific result is obtained or task completed.
  3. I will be paid primarily on a set fee or commission basis
  4. I do not primarily provide services at your place of business

(2) As your client, we are required to:

  1. Not treat you as an employee for employment tax purposes (e.g., we will not withhold taxes on income, social security or Medicare) or make payments for unemployment or workers’ compensation insurance.*
  2. Submit a Form 1099-Misc (covering your annual remuneration) to you and to the Federal government following the end of our fiscal year.

SIGNED: 

INDEPENDENT CONTRACTOR

Co. Name: ____________________________________________________________________

Address: _____________________________________________________________________

City, State, Zip: _______________________________

Phone: __________________________

Signature and Title:_____________________________________________________________

Date: ____________________________

Social Security Number:_______________________

CLIENT

Co. Name: ____________________________________________________________________

Address: _____________________________________________________________________

City, State, Zip: _______________________________

Phone: __________________________

Signature and Title:_____________________________________________________________

Date: ____________________________

*For your information, you will need to pay your own income and self-employment taxes

Key Topics

Contractor and Businessman handshake on construction site