What Constitutes Contract Labor?
If you need workers for your business, it is important to know whether they should be classified as employees or independent contractors, because this distinction carries important tax consequences. There is no clear legal dividing line between an employee and an independent contractor; the IRS will look at several factors to make the determination.
Other People Are Reading
-
Behavioral Control
-
The more behavioral control you exercise over workers, the more likely it is that the IRS will classify them as employees rather than independent contractors. This includes control over when and where work is to be performed, what type of equipment to use, where supplies are to be purchased, which tasks must be performed by whom, and which tasks must be performed in what order.
Financial Control
-
The more financial control you exercise over the worker's job, the more likely it is that the worker will be considered an employee. An independent contractor normally invests far more heavily than an an employee in the work tools and equipment he uses. Employees are more likely to have their out-of-pocket expenses reimbursed. Independent contractors have more freedom than employees to market their services to others. Employees are usually paid by the hour, while independent contractors are usually paid a flat fee and face the prospect of losing money if they work inefficiently.
-
Type of Relationship
-
A written contract may state that the worker is an employee or an independent contractor. Although the IRS is not bound by such a statement, the stated nature of the relationship will be taken into consideration when determining the status of a worker. Benefits such as insurance and paid vacations may indicate an employment relationship. Finally, independent contractors are often hired only to complete a specific project, while employees may be hired for an indefinite duration.
Statutory Exceptions
-
In some cases, federal and state statutes classify certain types of workers as either employees or independent contractors regardless of the foregoing factors. Full-time life insurance agents, for example, are classified as employees as long as they work for a single insurance company. On the other hand, sales staff and real estate agents paid on commission are treated as independent contractors regardless of any of the foregoing factors, as long as they labor under a written contract that classifies them as independent contractors.
Tax Consequences
-
If your workers are classified as employees, you must withhold from their paychecks income taxes and Medicare and Social Security taxes. You also must pay the employer's portion of Medicare and Social Security taxes as well as unemployment taxes.
As an employee, you are expected to file IRS Form 1040 each tax year. As an independent contractor, are also expected to pay quarterly estimated taxes, but will be able to deduct business expenses from taxable income much more easily than an employee can.
-
References
Resources
- Photo Credit construction worker, image by Greg Pickens from Fotolia.com
