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Employees vs. Independent Contractors

There are only two categories of workers for federal tax purposes: employees and independent contractors. Determining whether a worker is an independent contractor or an employee is of critical importance because federal and state income taxes must be withheld from an employee’s compensation. In addition, an employee’s wages are generally subject to Social Security and unemployment taxes. On the other hand, payments to independent contractors are not subject to any of these tax responsibilities. Thus, it can be beneficial to categorize a worker as an independent contractor, since this classification eliminates the need for performing many of the accounting and record keeping functions required for employees.

Determining whether an employer/employee relationship or a client/independent contractor relationship exists involves assessing the degree of control the person or entity has over an individual performing services. The key is to examine the level of control, not only with respect to the final result to be accomplished by the worker, but also with the manner and means by which that result is achieved. The greater the level of control, the greater the likelihood that the worker is an employee and not an independent contractor. An employment relationship generally exists where the person or entity contracting for services has the right to control not only the result of the services, but also the means by which that result is accomplished. This is true even where the parties fail to understand the exact nature of their relationship or misconstrue that relationship to be one of an independent contractor.

Thus, when a person is given a task free from supervision using their own judgment in performing that task, their own work schedule, their own tools and materials, and is paid on a per job (rather than per hour or salaried) basis, the individual probably qualifies as an independent contractor. However, if the individual is required to perform the task at certain times, under regular supervision, at the principal’s place of business, and using the principal’s tools and materials, an employer/employee relationship likely exists. If an employer/employee relationship exists, any contrary classification of the relationship by the parties will be disregarded. The true nature of the relationship is controlling, not the label applied to it by the parties in their contract. Thus, where a written contract clearly calls for an independent contractor arrangement, but the realities of the relationship demonstrate close control of the worker by the principal, neither the courts nor the IRS will hesitate in reclassifying the relationship as that of employer/employee.

    -Ean Harris