How to Properly Classify your Workers as Contractors or Employees

Determining if a worker should be an employee or a contractor is based on a number of factors.  The following steps should be used in conjunction with each other to ensure your business will have a reasonable basis for classifying a worker as either an employee or an independent contractor if ever asked by the IRS.  Why is this important? If a worker is an employee, you will be responsible for withholding payroll taxes from their pay versus if the worker is a contractor, they will be responsible for paying their own taxes.  Your business is responsible for reporting payments made to employees and contractors.  Form W-2’s are used to report compensation paid to employees, while Form 1099’s MISC or NEC are used to report payments made to those you may have paid rent to and contractors:

1. Assess the relationship between your business and the worker

If your worker provides services to many businesses, besides your own, they are an independent contractor.  If the worker only works for you, then additional factors need to be considered before you can be certain of subcontractor treatment.  Specifically, the degree of control and level of independence in the relationship between your company and the worker in question should be reviewed.  The IRS has three categories you can use as a guide in your assessment.  Read more.

Some questions to ask yourself in deciding whether or not your worker is an employee or an independent contractor are:

• Does my company control how this person does their job?
• Is my company providing training and other instructional guidance to the worker to direct how the job is done?
• Does my company provide the tools and other equipment needed for the job?
• Does my company reimburse the person for expenses they incur while working?
• What are the terms of our contractual agreement?

Some examples where it is clear cut as to employee or contractor determination:

Example 1

During the course of operating your business, you paid the following individuals:

• Your CPA who does not operate under a corporation
• Janitor who operated as a sole proprietor
• Landscaper who operated as a sole proprietor

In this scenario, all three individuals would be consider contractors of your company for which you would issue a Form 1099NEC at yearend to report payments made to each during the course of the year if the amounts were at least $600.

2. Let the IRS help you make the appropriate determination for your worker

If after reviewing the relationship between your business and your worker you are still uncertain of the appropriate classification, file Form SS-8 for IRS assistance in making this determination.

3. Keep records that document your worker’s relationship

If you determine the worker is a contractor, you should have a contract that details your agreement with them and any other documentation for support.

In closing, determining whether a worker is a contractor or an employee is not always straightforward, but following these steps will help you develop a reasonable basis for making your decision.