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The Difference Between Contractors And Employees

Before they file their taxes, it is critical that employers and workers have determined whether the work they have performed or paid for is considered contract or employee work. This is because contract and freelance work have different tax laws.  Also, the IRS may audit or fine companies that misclassify their employees as contractors.  Since the deadline to send information returns to the IRS is at the end of February, this distinction should be made as soon as possible.

Contractors and employees are subject to different tax withholdings. For employees, their employer is required to deduct the appropriate social security, Medicare, unemployment insurance, worker’s compensation, and other state taxes from their employee’s wages. The split between the employer and employee is approximately 50%.

As a result, employers end up paying substantially more taxes for work done by employees rather than contractors. Employers pay few to no taxes for contractors, who are required to calculate and pay self employment, social security and other taxes on their own. Also, contract work is not subjugated to minimum wage laws.

The question of whether a worker is an employee or contractor is ultimately a question of independence and control. Contractors are independent workers who do not have work terms dictated to them (when, how, and where they work) outside of what is agreed upon by the independent contractor agreement. A contractor’s client is allowed by law to specify what is expected as a final result of the contractor’s work.  On the other hand, employees are allowed by law to have work terms dictated to them.

The Internal Revenue Service recommends determining whether a worker is a freelance on contractor with three factors: behavioral control, financial control, and the nature of the relationship.  The more that an employer controls these three factors with a worker’s job, the more likely the worker is an employee and not a contractor.

Behavioral control is defined as whether or not the employer has control over the worker’s actions at work and how the worker performs. Financial control refers to whether or not the worker’s earnings are determined by the employer and how much of the cost to the worker is reimbursed. The type of relationship refers to the type of contract between the worker and employer, whether or not there are employee benefits such as sick leave and vacation, and the length of the worker relationship with the employer is taken into account.

The IRS says that there is no “magic number” of controls that classifies a worker as an employee or contractor. The IRS recommends that if there is still a reasonable doubt on the classification of a worker after reviewing the three factors, then IRS Form SS-8 should be filled out by a worker or employer and sent to the IRS to have an official classification made.

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Erich J. Ruth

Erich J. Ruth provides technical support for National Software which is the parent company for 1099FIRE. 1099FIRE develops and markets a comprehensive range of products that enables any size of business or institution to effectively manage and comply with year-end filing requirements. 1099FIRE is an employee-owned company located in Phoenix, Arizona.

If you have any questions or comments about our software, feel free to contact us at any time.

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