Providing employee benefits to individuals who work for you are used to help attract and retain high caliber people. Because of the economic downturn, many of our clients are hiring individuals as independent contractors and not withholding any taxes or paying any benefits. Under what circumstances will these individuals be considered employees?
Deciding whether a worker is an independent contractor or an employee depends on three main categories: behavioral control; financial control; and relationship of the parties.
Behavioral Control
These facts show whether there is a right to direct or control how the worker does the work. A worker is an employee when the business has the right to direct and control the worker. The employer does not have to actually direct or control the way the work is done – as long as the employer has the right to direct and control the work.
Financial Control
Certain facts show whether there is a right to direct or control the business part of the work: significant investment in his or her work; expenses that are not reimbursed; opportunity for profit or loss.
Relationship of the Parties
These are facts that illustrate how the employer and the individual perceive their relationship:
When an individual is an employee
The employer must withhold income tax and the individual’s portion of social security and Medicare taxes. Also, the employer is responsible for paying social security, Medicare, and unemployment (FUTA) taxes on the employee’s wages. The employer must provide the individual with a Form W-2, Wage and Tax Statement, showing the amount of taxes withheld from his or her pay.
An individual may deduct unreimbursed employee business expenses on Schedule A of his or her income tax return, but only if the individual itemizes deductions and his or her total more than two percent of his adjusted gross income.
When an individual is an independent contractor
The employer may be required to give the individual a Form 1099-MISC, Miscellaneous Income, to report what it has paid to the individual.
The individual is responsible for paying his or her own income tax and self-employment tax (Self-Employment Contributions Act – SECA). The employer does not withhold taxes from the individual’s pay. The individual may need to make estimated tax payments during the year to cover his or her tax liabilities.
The individual may deduct business expenses on Schedule C of his or her income tax return.