Employee or Independent Contractor

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Employee Classification
The first step is to classify your new hires. When your business expands, there are several hiring options. Each option has certain payroll tax implications. This section will help you understand the choices available, as well as the costs and benefits associated with each classification.

What is an Employee?
For payroll accounting purposes, workers generally are classified as either employees or independent contractors. How a worker is classified will directly affect withholding and remitting income and Social Security taxes and also how the earnings are reported to the government. Classification is an important matter to the worker, employer, and government.

The common law test will determine if federal, state and local income taxes should be withheld from the worker and then remitted to the appropriate taxing agency by the employer. The results of the common law test will also determine if an employer must pay federal and state unemployment taxes on a worker's earnings. The key issue in the common law test is the amount of control that the employer has over the worker. Or in other words, how "independent" the worker is.

Four points in the common law test determine if the worker is an employee:

• Does the employer have the power to fire or terminate the worker at will?
• Does the employer provide a place for the worker to work, such as a workbench in a shop or a desk in an office?
• Does the employer provide the worker with tools, supplies, uniforms, or other items used on the job?
• Does the employer have a voice and responsibility in what the worker does and how the worker does a job?

If all four questions can be answered "yes," the worker should be classified as an employee. If there are "no" responses to the questions, the worker should be classified in another way, such as an independent contractor.

If a worker is classified as an employee, the employer must:

• Withhold income and Social Security taxes from the employee's pay.
• Match the Social Security taxes each employee pays.
• Pay federal and state unemployment taxes on each employee's earnings.
• Issue a Form W-2 to each employee after the end of each calendar year.

The following table illustrates important distinctions between employees and independent contractors:

Employee	Independent Contractor
Required to comply with employers instructions about when, where, and how to work	Sets own hours; determines own sequences of work
Hired by the employer	Works for other employers; services available to the public
Has a continuous relationship	Hired by a leasing company; self employed
Subject to dismissal; can quit without liability	Under contract that governs how the relationship can be severed
Work done personally	Permitted to hire assistants
Paid a salary; reimbursed for expenses; participates in company’s fringe benefit program	Payment by the job; opportunity for profit and loss
Furnished tools, equipment, materials and training	Furnishes own tools, equipment, and training; substantial investment by the worker
Works at the employers premises	Works by the job
Wages and earnings reported on form W-2	Wages and earnings reported on form 1099
Performs services under the company’s name	Performs services under the worker's business name

Other Classifications of Workers
A worker who is not classified as an employee might not be an independent contractor either. Individuals such as insurance agents, real estate agents, outside salespeople, and direct sellers are classified as statutory employees. Under the statutory employee classification, an employer is responsible for withholding only Social Security and Medicare taxes on earnings. A worker can also be considered a temporary agency employee or a leased employee.

The chart below shows the employer's responsibilities for these classifications.

Worker Classification	Examples of this Type of Worker	Who is the Employer of this Worker?	Are Taxes Withheld for this Worker?	Who Pays Social Security and Medicare Taxes?
Leased Employees	Professional positions or special assignment employees	The worker is the employee of the leasing agency	Yes. The agency withholds all appropriate taxes	The agency matches FICA at 6.2% and Medicare at 1.45%
Temporary Employee	Clerical and many types of professional occupations	The worker is the employee of the temporary agency	Yes. The agency withholds all appropriate taxes	The agency matches FICA at 6.2% and Medicare at 1.45%
Statutory Employee	Insurance agents, traveling sales people and delivery drivers who receive commissions	The worker is the employee of the company that pays the commissions to the worker	No federal income taxes are withheld. Only FICA taxes are withheld for the employee	The agency matches FICA at 6.2% and Medicare at 1.45%