Is that an Employee or Independent Contractor?
By: Alex Rechenmacher

The legal distinction between an employee and an independent contractor, while commonly overlooked with regards to its implications, has real-life significance for both employers and employees.  Over the last few years, the IRS too has taken a closer look at the distinction in many cases.

Considering just federal taxes, for example, if a worker is an employee, the employer must withhold income tax and the employee's part of Social Security and Medicare taxes. The employer also is responsible for paying Social Security, Medicare, and unemployment taxes on wages. An employee can deduct unreimbursed business expenses if the employee itemizes deductions and the expenses are more than 2% of the adjusted gross income.

If the worker has independent contractor status, however, there is no withholding, and the contractor is responsible for paying income tax and self-employment tax. In that situation, it also may be necessary to make estimated tax payments during the year. An independent contractor can deduct business expenses, but on a different schedule of the tax return than is used by an employee.

So how do you tell the difference between an employee and an independent contractor? There is no single, quick answer.  Certainly, it is not settled by simple reference to the individual as one or the other in conversation or in documentation.  The particular facts of each case must be examined. However, relevant facts can be grouped into three general categories: behavioral control; financial control; and relationship of the parties.

Behavioral Control

The focus here is on who has the right to control how a worker does the work, rather than simply on the end result of the work. Generally speaking, if the business has that right, the worker is more likely to be considered an employee, however, if the worker retains that right, the worker is probably an independent contractor. The more that a worker receives instructions or training from the business on how the work is to be done-such as what equipment to use, whether to hire help, or where to get supplies-the more likely it is that the worker is an employee.  

Financial Control

In addition to the actual performance of work, there is the question of the right to control the dollars-and-cents part of the work. Rather than having a direct financial stake in the business, an employee essentially works for a paycheck and maybe some reimbursed expenses. Some factors pointing more toward an independent contractor status include a worker's significant investment in the work, his or her lack of a right to reimbursement of even high business expenses, and his or her potential to realize a profit or suffer a loss.

Relationship of the Parties

Finally, the last factor considers how the parties themselves perceive their relationship. While an independent contractor, as the term suggests, is on his or her own concerning benefits, a worker who is provided insurance, retirement benefits, or paid leave is probably an employee. Sometimes the clearest picture of a worker's status is to be found in a written contract. The parties' intent, as shown in a contract, can be a decisive factor, especially if the other facts do not lead to a conclusive answer.

Knowing the relationship status of the people working on behalf of a business is one of the many legal considerations that business owners and executives face each and every day.  The attorneys at the Law Offices of Edward P. Graham, Ltd. help our clients to understand these decisions and address their needs so that our clients can focus on achieving their goals. Click here for more information about our business practice areas.