How to Determine if Your Worker is an Employee or Contractor

Whether your business has 10 or 100 or more workers, you probably have a mix of employees and contractors helping service your customers and grow your company. Making the distinction between employee and contractor at the time of hiring is important—you’ll need this information to accurately report your team members on your business taxes.

How Do I Determine Who's Who on My Team?

Determining the status of a worker can be difficult. Both employees and contractors have a significant impact on the success of your company, and you can pay an employee or a contractor the same amount for very similar work. Also, you control their discharge or termination. 

This is why you need to consider factors when determining whether a person should be an employee or a contractor. This might be a complicated task, but it’s still important that you apply guidelines correctly. The type of worker determines factors like if you must withhold income tax, social security, Medicare, and unemployment tax from wages paid.

Here’s a general rule to get started: A worker is an independent contractor if the employer has the right to control the results of the work, but the employer cannot direct what, how, and when it will be done. 

But there are multiple factors to consider when going through this process. We’ve compiled these guidelines to help you sort out your employees and contractors:

Consider Behavioral Control

Does your business have the right to direct and control the person’s work performance? 

When and where to work, and where to purchase supplies and services

• When you dictate these guidelines, the person is an employee. If there are more instructions beyond a set of guidelines, the worker is an employee. 

• Fewer instructions mean the person is most likely an independent contractor. They are educated in their job. They provide their own tools and, in some cases, their own supplies. 

• Example: In the construction industry, a carpenter uses their own tools to create an end product following instructions or plans provided by you. This person is a contractor.

Evaluation of Results 

• Supervisors or managers evaluate employees’ progress over time. 

• A contractor is measured only on the end results or the work they produce.

Training & Skills

• Employee: Training on how to do the job with periodic or ongoing training about procedures and methods 
• Contractor: Follow their own methods and does need regular guidance from the client or another party 

Financial Control of the Worker

Does your business have the right to direct and control the financial aspects of the job being performed? 

• Equipment and Tools: Contractors use their own equipment when working for a client. Employers provide employees with the tools required for the job. 

• Expenses: Contractors cover their own expenses (they are not reimbursed) for things like fuel, parking, transportation, and deliveries. An employer reimburses employees for allowed expenses, which often includes things like fuel, parking, and transportation.

• Risk of Profit or Loss: Contractors’ risk is evident. They might exceed their time on a task, resulting in money loss, or they might complete the task quickly, resulting in a higher profit. Employees rarely have such a risk.

• Business Opportunities: Contractors seek out more business opportunities using their own financial means. Employees use the resources of their company. 

• Pay and Time: Contractors are paid a flat fee to do a job. While the time to complete a job doesn’t influence their pay, it is encouraged that you set up a contract that spells out the task timeline and payment. Employees receive a regular wage for the time they work (hourly, weekly,  monthly, etc.), and employees may be eligible for overtime or holiday pay.

Relationship with the Worker

How do the worker and business interact with each other?  

• Contracts: Contracts describe the relationship between the contractors and their clients. 

• Benefits: Employees typically receive benefits such as health or life insurance, pension plan, vacation pay, or sick leave. Contractors do not receive such benefits. 

• Relationship Length: A contractor’s relationship with you is for a specific period or until a job is completed. An employee’s relationship with you is not for a specific period or based on the completion of a job. 

Additionally, there are some characteristics that are more specific to a relationship with an independent contractor. Those include, but are not limited to: 

• Having more than one client that they provide services to

• Invoicing for completed work

• Owning fully their own work tools or materials

Employee or Contractor: The Bottom Line

You’ll want to understand who is an employee or contractor at your business to avoid costly mistakes. For example, misclassifying an employee as an independent contractor makes you liable for employment taxes. If you provide reasoning for deeming a worker as an independent contractor, employment taxes can be avoided.

For more information, visit Publication 1976, Section 530. You can also request that the IRS make a determination of status. While the process might take up to six months, it will provide an official determination of the worker’s status. You should use IRS Form SS-8 to request a determination.

While your business is gearing up to file your taxes, you might be worried that you have all the right information or unsure what forms you need to file for your independent contractors.