Independent Contractor or Employee?

Small business owners often use the services of freelancers, independent contractors, or other small businesses. As a business owner, you might think of these people as independent contractors. But the IRS might not see the situation the same way. One of the most common questions we have to face as small business owners is, who is an independent contractor and who is an employee? For example:

Your business hires a cleaning person from XYZ Cleaners, LLC. He’s not an employee, is he?

Your business hires someone to mow your lawn once a week. She’s not an employee, is she?

The answer to both questions is – it depends.

Under Section 102.07(8) of the Wisconsin Statutes, a person is required to meet a nine-part test before he or she is considered an independent contractor rather than an employee. He or she must:

  1. Maintain a separate business.
  2. Obtain a Federal Employer Identification number from the IRS.
  3. Operate under specific contracts.
  4. Be responsible for operating expenses under the contracts.
  5. Be responsible for satisfactory performance of the work under the contracts.
  6. Be paid per contract, per job, by commission or by competitive bid.
  7. Be subject to profit or loss in performing the work under the contracts.
  8. Have recurring business liabilities and obligations.
  9. Be in a position to succeed or fail if business expense exceeds income.

Although it is a little more complicated than this, many small business people I talk to do not realize that in order to make the decision on employer vs. independent contractor, they must work through the nine-part test. If your “contractor” doesn’t meet the criteria, then this individual is most likely an employee.

Why is this important? If you hire a person as an employee, you are required to pay Social Security and Medicare taxes on their wages. You also will generally be obligated to pay federal and state unemployment taxes. Workers’ compensation and other insurance may also be an issue. Employees may be eligible for retirement plan and other company benefits. These are all additional costs to the company.

Independent contractors are required to pay their own payroll taxes and generally pay for their own supplies, insurance, and other expenses.

Therefore, it is very important that business owners correctly determine whether the individuals providing services are employees or independent contractors.

Both IRS and Wisconsin’s Department of Workforce Development have some good educational materials on their websites. Most can be accessed by typing “independent contractor” in the websites’ search boxes.

The classification of employees is very important. Under IRS rules, if you classify an employee as an independent contractor and have no reasonable basis for doing so, you may be held liable for employment taxes for that worker. This can be very costly.

There is currently a Voluntary Classification Settlement Program (VCSP) that provides taxpayers with an opportunity to reclassify their workers as employees for future tax periods and allows for some partial relief. If you feel that you fall into this category, you may want to look into the VCSP and, if needed, apply for the program using Form 8952.

IRS Circular 230 Disclosure: To ensure compliance with Treasury Department Regulations, we advise you that, unless otherwise expressly indicated, any federal tax advice contained in this communication was not intended or written to be used, and cannot be used, for the purpose of (i) avoiding tax-related penalties under the Internal Revenue Code or applicable state or local tax law provisions or (ii) promoting, marketing, or recommending to another party any tax-related matter addressed herein.