Employee or Independent Contractor?

Which is Which?

Telling an employee apart from a contractor can be a difficult task, but one that has resonating consequences.

The IRS, labor departments, and other state regulators often look closely at the classification of workers to ensure that it is done correctly. If not, it can lead to fines, payment of back taxes, and other penalties.

The main question comes down to Control—who has it, who gives it, and what does control imply in terms of timeline and materials.

What is an Employee?

An Employee is a worker who performs a job under the direction of an employer. The employer controls how the employee works; when an employee works; and what the employee does.

Take Susan Sample. She is an architect.

· Her firm tells her which days and times to work. In her case, Monday through Friday 8am to 4pm.

· If she wants to take time off or make a change in assignment, she must request permission for her supervisor.

· Her employer provides an office and computer on which for her to do her work. She also receives a laptop for meeting clients outside of the office

· She is paid a specific wage

· Her clients belong to the firm, not to her

· She may receive benefits, such as funds toward retirement and healthcare, as part of her job

An employee receives a W2 at the beginning of the year. As part of their onboarding, they submit a Form W4, a Form I9, and whatever state forms required.

Employers file payroll Forms 940 and to the IRS, reporting what is paid, in a quarterly fashion. At the end of the year, they file Form W2. Employers are responsible for a share of employer payroll taxes, including federal and state unemployment.

What is a Contractor?

An independent contractor controls their time, money, materials, and assignments. Even though an independent contractor may feel as if they are not running their own business (ex: a handyman who does jobs around town at various times), under law they are.

Going back to Susan. If she were an Independent Contractor with a relationship with Architects LLC

· She could refuse to take on assignments

· She would determine the deadline, in agreement with the corporation, and would work at her own pace. If she doesn’t want to work Monday, she doesn’t have to

· She uses her own computer, drafting boards, and laptops for her work

· She is paid by the hour or by the job and receives no benefits

· She funds her own retirement from her profits. Same with healthcare

Independent contractors are often hired for their expertise, such as Susan’s expertise in designing open floor home plans. Contractors like her are hired to do specific jobs, but they aren’t told how to do the work, what tools and supplies to be done, or when to do the work. Deadlines are often specified but contractors do not receive schedules.

Independent contractors receive Forms 1099-NEC at the end of the year. They are usually asked to submit a Form W9 when the contract is accepted, and work begins.

Businesses that hire independent contractors report the total paid to the IRS by submitting Form 1096 with 1099-NECs attached. They do not pay any payroll taxes on this work performed.

Rules to Consider

The IRS relies on 3 common factors to determine if a worker is an employee or a contractor.

1. Behavior. Who controls the worker and the manner in which the work is done?

2. Financial. Does a company control a worker’s pay? Do they reimburse a worker for expense? Do they provide equipment to allow the worker to complete their job?

3. Type of Relationship. Is there a contract specifying the relationship? Are there benefits or set hours?

The IRS has more in-depth guidelines here.

California and the ABC Test

Some states have their own regulations for determining worker status. California and a few other states use the ABC test. All three factors must be met for the worker to be classified as an independent contractor. This test is stricter and may result in more classifications as an employee.

A. The worker is free from control and direction of the hiring company in the performance of the work

B. The worker performs work that is outside the usual course of hiring

C. The work customarily engages in an independently established trade, occupation, or business of the same nature as the work performed for the hiring entity

Under the ABC test, Susan might be considered an employee. The law does carve out exceptions to specified trades, such as architects, enrolled agents, surgeons, direct salespeople, and other professional trades.

ABC in California is a complex web of standards and laws. If you are unsure of how a worker should be classified, contact an employment attorney to review your worker status.

As part of the BQ family, you have access to our referral network, which includes labor and employment attorneys.