When it comes to worker classifications, there are two types; a full-time employee and an independent contractor. Deciding between these two classifications will impact how you manage, pay, and file taxes for the worker. Additionally, making the incorrect determination on the worker’s classification can be an expensive mistake and cost you significant fines. So, it’s always better to get it right the first time and avoid headaches and fines in the future.
As a business owner and employer, it is your responsibility to determine whether the worker is an employee or independent contractor. While it is your responsibility, the IRS can provide guidance on the determination.
The Common-Law test is a guide provided by the IRS to aid you in your determination. This test examines whether the employer retains the right to control the means and methods of a worker’s performance in three specific areas:
- Behavioral – Does the company control what the worker does and how the worker does their job?
- Financial – Are employees paid on a schedule that the employer sets? Are business aspects of the worker's job controlled by the employer?
- Type of Relationship – Is the working relationship ongoing, and is the work essential to the business? Or is it defined by a contract and specific to a defined scope of work?
If the employer retains the right to control the three categories above, the worker is likely considered an employee.
Below are some common differences between the two classifications:
- The IRS defines the employee's work as being directed and controlled by you, the employer. A traditional 9 to 5 worker that receives specific direction on how and when to complete work will likely fall under the employee classification.
- Works on an ongoing basis and may be terminated at will.
- Is told how to perform work, in what order, and which particular tools to use.
- The employer does not direct the work of an independent contractor. Instead, the employer directs the results of the work.
- Independent contractors do not receive explicit instructions on what will be done and how it will be done, only the result.
- Independent contractors do not need or receive skills training.
These two classifications can be tricky, and it is important to get it right, otherwise, you could find yourself paying penalties or fees. If you still aren't sure whether you are hiring an independent contractor or an employee, check out the IRS's regulations first.
The rest of this guide applies to hiring employees. If you have determined that you are hiring an independent contractor, check out our article on paying an independent contractor.