The distinction may be challenging to make sometimes, but the IRS has very strict rules about it.
Depending on the size of your business, onboarding a new hire can involve a lot of reading and writing for both of you. You may want the new worker to fill out a personal profile. There could be a company handbook for the individual to read and detailed job specifications and a contract to absorb. And tax forms.
But which tax forms? That depends entirely on whether your new staff member is an independent contractor or an employee. The distinction involves more complex issues than their actual physical work location (your office or elsewhere) and their schedule (full-time 9-5 or an odd assortment of part-time hours).
The IRS takes this distinction very seriously. So seriously, in fact, that it’s been known to do lengthy investigations of large companies to determine whether staff members are being classified correctly.
You’ll need to determine whether workers are employees or independent contractors, so you know which tax form to send in January, a 1099-NEC or a W-2.
If you’re hoping for a magic formula that will help you make this determination, you’re not going to get one from the IRS. The agency does lay out the factors it looks at, but they’re somewhat murky. You have to look at three different elements of the relationship between management and workers as you try to make this call. They are:
- Behavioral. How do the workers do their jobs, and what do they actually do? Does the boss control this or the employee/contractor?
- Financial. Do workers pay for their own computers and smartphones and the other supplies and tools required to do their jobs, or does management? How are individuals paid? Are their expenses reimbursed? You’ll need to look at various aspects of the business relationship.
- Type of relationship. Will this be an ongoing relationship? Are there “extras” involved besides basic compensation, like employee benefits (health insurance, retirement plans, etc.) and written contracts? Will the new staff member be providing a work product that is a “key aspect of the business?”
What you’re looking closely at here is control. How much control does the boss have over employees or independent contractors?
You may get frustrated as you try to answer these questions. It may seem that some of your answers would indicate that the individual is an independent contractor, while others point to employee status. You might also discover that some of the individual’s work and workdays fit one definition while other work would indicate the other.
Like we said earlier, there’s no magic formula you can use to make this determination.
A Helpful IRS Form
If you absolutely can’t determine whether an individual is an employee or independent contractor, you can try to get help from the IRS by completing a Form SS-8.
You may find that you simply can’t make a determination based on how the IRS wants you to define your relationship with a specific worker. If that’s the case, you can complete and submit the multi-page IRS Form SS-8: Determination of Worker Status for Purposes of Federal Employment Taxes and Income Tax Withholding. This may help, but unfortunately, it takes roughly six months for the IRS to respond to your query. It may even take longer considering the slowdowns caused by the COVID-19 pandemic.
You’ll also have to contact your state’s labor office because each state has its own criteria for determining a worker’s status based on unemployment insurance and workers’ compensation laws. In addition to the questions the IRS poses, some states ask you to consider how economically dependent the person is on your business. Go to this page to find contact information for your own state’s labor offices.
Help With Onboarding?
If you’re in the process of hiring a new staff member or plan to during 2021, keep in mind that you’ll need to know immediately which IRS tax form you need to have them complete before you pay them for the first time. An independent contractor will get a W-9 (usually no taxes withheld) and an employee, a W-4 (taxes withheld).
Hiring an independent contractor is generally fairly easy. They usually send you invoices for their work. You pay them, and they’re responsible for their own income taxes. Onboarding an employee, however, is a more complex process, primarily because of the income tax piece. We encourage you to contact us if you’re having trouble distinguishing between employees and contractors and/or if you’d like help dealing with taxes for a new hire. We’ve worked with other small businesses in this area, and we’d be happy to assist you.