It is important to understand and correctly classify a worker as an employee or contractor. If the worker is classified as an employee, you must withhold income taxes and pay Social Security, Medicare taxes and unemployment tax on wages paid. At the end of the year, an employer issues a Form W-2 to each employee. If the worker is classified as an independent contractor, then you normally don’t have to withhold or pay any taxes. At the end of the year, a business issues a Form 1099 to each contractor. The earnings of a person working as an independent contractor are subject to self-employment tax through the filing of their individual income tax return.
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, not what will be done and how it will be done. Small businesses should consider all evidence of the degree of control and independence in the employer/worker relationship. Whether a worker is an independent contractor or employee depends on the facts in each situation.
To be able to correctly classify a worker, several key elements must be taken into consideration. A good resource to leverage for making this determination is the comparative approach guide provided by the Texas Workforce Commission. This test gives a comparison between an employee and an independent contractor taking into consideration 20 key factors. We have provided a screenshot of Form C-8 that was issued by the Texas Workforce Commission.
We recommend working with your attorney and CPA to ensure your workers are classified correctly and you are in compliance with labor law as well as federal and state tax regulations.
Read what the IRS says about understanding employee vs contractor designations.
This post may not contain a complete analysis of the tax issues discussed herein and does not represent official conclusions or advice regarding the matter.