I do the books for a number of small business owners who provide their services to larger companies. In most cases, they are known as independent contractors. But depending on which federal agency you ask, an independent contractor might actually be an employee.
So how do you tell the difference? The IRS says the general rule is that “an individual is an independent contractor if the payer has the right to control or direct only the result of the work and not what will be done and how it will be done”. But according to the US Department of Labor, and the Fair Labor Standards Act, there are six factors that distinguish Independent Contractors from an Employee, including:
- IMPORTANCE OF SERVICE OR SERVICES – Does the worker play an essential role in the business? Can your business exist without this person? For example, if you own a roofing company and you hire an extra roofer for a job, would that person be considered an employee or an independent contractor? Does the worker supervise any of the company’s employees? If you answered yes to any of these questions, you may have to put your worker into the employee category.
- LENGTH OF SERVICE – How long someone has worked for the same company, could factor into whether they are an employee or an independent contractor.
- WORKER’S INVESTMENT – Is the worker using his or her money to buy equipment? Independent contractors do this. But if the worker is getting reimbursed for supplies, he or she may be considered an employee.
- WHO HAS CONTROL – Who decides the worker’s hours, if he or she can work for another company or what the worker’s pay rate is? If the worker does, then he or she leans towards being considered an independent contractor.
- PROFIT AND LOSS – Does the worker profit by doing the job more efficiently? This is a big tell between an independent contractor and an employee.
- SKILL LEVEL & MARKETING – Another factor the US Department of Labor considers is the level of skill required in performing the job. Does the employee need training or can they perform the task without it? The agency also takes into account advertising, such as whether or not a worker has their own company website? Does the worker have his or her own business cards?
It takes more than one factor to determine if a worker is an independent contractor or an employee, so review the list next time you make a new hire.
Outsourcing to independent contractors is a great way for a small business owner to focus on what they do best and get everything done. But make sure you categorize your employees and independent contractors correctly to avoid tax problems, especially a future audit from the IRS.
Have a great week everyone!