Is it better to be an independent contractor or an employee? For a small business owner (SBO), the question mostly is, how to determine what business relationship exists between the person providing the services & the SBO; and if that relationship is that of an independent contractor or an employee.
So how is that determination made?
Common Law Rules fall into 3 categories. Behavioral: Does the company have the right to control what the worker does & how he does it?; Financial: Are the business aspects of the worker’s job controlled by the payer?; And the Type of Relationship: Are there written contracts or employee type benefits?
•The general rule of thumb is that one is an independent contractor if the payer (of the fees) has the right to control or direct only the result of the work and not what will be done and how it will be done.
•Hence you are not an independent contractor if you perform services that can be controlled by an employer (what will be done & how it will be done). You may have freedom of action but the employer has the legal right to the details of how the services will be performed.
An independent contractor is considered self-employed and employee is not.
One must look at all of the above points to determine whether a worker is an independent contractor or not. There is no set formula to determine a worker one way or the other. The matter has to be decided after careful evaluation of the entire relationship, considering the extent of the right to control and direct. And these factors have to documented.
If the business or the worker cannot make that determination on their own, Form SS-8 can be filed with the Internal Revenue Service, they will review the facts and make a determination for you. It may take at least 6 months for the IRS to make that determination.
Once this relationship is established and the determination made, the appropriate forms and associated taxes have to be filed:
•For Independent Contractors: Forms W-9 and Form 1099-MISC. The W-9 is given to the worker to complete. This is needed to obtain the correct name & the Taxpayer Identification Number which can be a SSN or EIN. The 1099-MISC has to be issued if a business paid any contractor more than $600 in a year. You may qualify for an exception to filing Form 1099-MISC. From that point, an independent contractor is responsible for filing his own taxes.
•For Employees: Withholding the correct federal & state taxes, FICA and medicare & any other benefits provided and depositing them on time is a big responsibility for employers. This has to be done in collaboration with professionals in that area.
In spite of taking all the above steps, if one thinks they have been /or have misclassified a worker, there is recourse for that. This can be done by filing Form 8919 and attaching it to the tax return, Form 1040.
The IRS has also announced the Voluntary Classification Settlement Program via their Announcement 2012-45 . For more information on this program, you could visit the IRS Website here.