In a struggling economy where so many are shifting focus to make ends meet, more people are steering toward becoming independent contractors. The popularization of the “gig economy” by companies such as Uber and Instacart and the coronavirus pandemic impact has caused many to turn their side work into a full-time job. Although many may not understand the difference in classification between working as an employee or as an independent contractor, the answer to this question determines your tax liability.
Your classification as an employee or independent contractor is important because it determines if your employer must withhold income taxes and pay Social Security, Medicare taxes, and the unemployment tax on any employee’s wages. Businesses are not required to withhold or pay any taxes on payments to independent contractors. Instead, the earnings of a person working as an independent contractor are subject to self-employment tax. Furthermore, if your employer misclassifies you, he may be subject to serious fines.
The general rule is that an individual is an independent contractor if the payer has the right to control or direct only the work result, not what will be done and how it will be done. Small businesses should consider all evidence of the degree of control and independence in the employer/worker relationship.
The following distinctions can help you classify yourself as either an employee or an independent contractor. Current law defines someone as an “employee” unless they meet all of the following criteria:
- Behavioral control – You have no director overseeing you; You have complete control over what you do. It is important to note that Periodic or on-going training about a company’s procedures and methods is strong evidence that the worker is an employee. Independent contractors ordinarily use their own methods.
- Financial control – You were hired to do work for a company that does not do the type of work that you do; This type of work is not performed on the premises of the company’s building in any way.
- Relationship – You are usually involved with a trade or profession that is independently established. The permanency of the relationship is essential. An expectation that the relationship will continue indefinitely, rather than for a specific project or period, is generally seen as evidence that the intent was to create an employer-employee relationship.
Employees are entitled to unemployment and workman’s compensation benefits for injuries that happen while on the job. Independent contractors don’t have an employer that would offer them these benefits or pay into various payroll deductions. Even though this makes more of their gross income theirs, employers’ absence of benefits and legal protections doesn’t mean that taxes do not have to be filed.
Do Your Classifications Hold Up to IRS Interrogations
The IRS has a set of diagnostic questions to determine whether someone is an employee or a small business.
Were you trained? Employee.
Did you receive tools and materials from an employer? Employee.
Did you suffer a profit or loss under multiple employers? Independent Contractor.
Are you paid a regular paycheck by the hour, week, etc.? If so, you may be an employee.
The IRS Small Business and Self-Employed Tax Center on the IRS website offer helpful resources. Visit the IRS to learn more about the difference between these two classifications and call Estess CPAs if you have any questions. At Estess CPA, we specialize in the needs of individuals and small businesses with tax planning, accounting, bookkeeping, and payroll services.
Call us today and schedule an appointment at our Belle Chasse or Luling offices:
7822 Highway 23 128 Lakewood Drive
Belle Chasse, LA 70037 Luling, LA 70070
(504) 433-5122 (985) 785-1470