The IRS uses common-law rules to help businesses decide whether a worker should be classified as an employee or an independent contractor. Correct classification is critical because it impacts tax withholding, benefits, and compliance.
The IRS evaluates three key categories: behavioral control, financial control, and the type of relationship between the business and worker.
1. Behavioral Control
Behavioral control measures how much the business directs or controls the work performed. The IRS considers:
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Type of Instructions Given – Employees typically follow detailed instructions on when, where, and how to work. Contractors usually decide these details on their own.
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Degree of Instruction – The more detailed the instruction, the more likely the worker is an employee.
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Evaluation Systems – If performance is closely monitored and reviewed, the worker may be classified as an employee.
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Training – Detailed or ongoing training suggests employee status, since contractors usually determine their own methods.
2. Financial Control
Financial control looks at how much the business manages the worker’s financial aspects. Key factors include:
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Significant Investment – Independent contractors typically provide their own equipment or tools.
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Unreimbursed Expenses – Contractors generally incur more out-of-pocket expenses than employees.
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Opportunity for Profit or Loss – Contractors face the possibility of profit or financial loss, unlike employees who receive steady pay.
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Services Available to the Market – Contractors can market their services to multiple clients, while employees typically cannot.
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Method of Payment – Employees are usually paid hourly or by salary, while contractors may be paid per project or via a flat fee.
3. Type of Relationship
The IRS also considers the overall relationship between the business and the worker. Factors include:
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Written Contracts – Contracts may state employee or contractor status, but the IRS is not bound by them.
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Employee Benefits – Employees are more likely to receive benefits such as health insurance, vacation, and retirement plans.
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Permanency of the Relationship – Permanent or indefinite work suggests employee status; project-based work suggests contractor status.
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Key Activities of the Business – Workers performing essential business functions are more likely to be classified as employees.
Making the Right Classification
Businesses must evaluate all these factors before deciding worker status. No single factor determines the outcome; instead, the IRS looks at the entire relationship. If there is any doubt, the IRS allows businesses to request an official determination using Form SS-8.
How 1099FIRE Can Help
At 1099FIRE, we provide software and services that help businesses stay compliant with IRS reporting rules. Our team can:
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Assist with Form SS-8 submissions to clarify worker status.
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Provide e-filing solutions for 1099 and W-2 forms.
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Reduce errors and penalties related to misclassification.
Contact us at support@1099fire.com or call (480) 706-6474 to discuss your compliance needs.