Contractor or Employee? Knowing the difference is Important

Is a worker an independent contractor or an employee? As an employer, getting this wrong could land you with an IRS audit and cost you plenty in many other ways. Here's what you should know:

As the worker: If the worker is a contractor and not considered an employee, he/she must:

• Pay self-employment taxes (Social Security and Medicare-related taxes).
• Make estimated federal and state tax payments.
• Handle his/her own benefits, insurance and bookkeeping.

As the employer: You must ensure your employee versus independent contractor determination is correct. Getting this wrong in the eyes of the IRS can lead to:

• Payment and penalties related to Social Security and Medicare taxes.
• Payment of possible overtime, including penalties for a contractor reclassified as an employee.
• A legal obligation to pay for benefits.

When the IRS recharacterizes an independent contractor as an employee, they look at the business relationship between the employer and the worker. The IRS considers if the employer has the right to control the work (when, how and where the work is done) and the financial relationship (i.e., a contractor has a contract and customers, and invoices the company).

The more reasonable your basis for classification and the more consistently it is applied, the more likely an independent contractor classification will not be challenged.