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This brochure provides a summary of classifying workers as independent contractors or employees. You should always discuss with your CPA the details of classifying workers before making any decisions concerning this issue.

Workers generally fall into one of two categories, "independent contractors" or "employees." Most laws define independent contractors as sole proprietors, rather than employees of a company. The classification of a worker significantly affects employer payroll taxes and the employee’s taxes and benefits. The payer for an individual’s services may want to classify a worker as an independent contractor rather than an employee to reduce payroll taxes and benefit costs. Workers may want to be classified as independent contractors to avoid having income tax withheld from their paychecks and being able to avoid the 2% limitation on expenses applicable to employees. However, workers must be classified correctly to avoid being reclassified as an employee and owing back employer payroll taxes and penalties. A worker is assumed to be an employee unless it can be proven that they are an independent contractor.

Many companies use the IRS' 20 factors, which are briefly described on the opening page of this brochure, as a guideline to classifying workers; however, these factors should not be the only consideration when determining whether a worker is an independent contractor or an employee. The facts and circumstances of a worker’s duties must be examined in detail.

  • If workers are NOT in the business of doing the same thing for several entities at the same time, they should be treated as employees.

  • If workers DO NOT have their own business license, letterhead, marketing plan, separate tools and equipment and a distinct, individualized company of their own, they should be treated as employees.

Independent Contractor or Employee?

In addition to being an employee or independent contractor, a worker can also be a statutory employee or nonemployee, which means a worker, depending on the type of work, is automatically classified by law as an employee or nonemployee (independent contractor), regardless of the characteristics of situation.

Statutory Employees

Federal income tax law treats compensated corporate officers as statutory employees and social security and medicare rules treat full-time life insurance agents as statutory employees also.

Common Law Employees

These workers are considered employees because the employer has direct, legal control over 1) what must be done and 2) how it must be done, whether or not the right is exercised, and the workers cannot be proven to be independent contractors in any other way.

Independent Contractors

For an individual to be an independent contractor, a company may only have direct control over what must be done. The company may not specify how, when or where the work is to be performed. Some examples of independent contractors are lawyers, doctors, CPAs, architects and contractors, all who offer their services to the public. However, if the payer has legal control over how these individuals perform the work, they are considered employees. Some companies require that a worker have a business license and sign a contract for the services.

The IRS’ 20 factors can be helpful in determining whether a worker may be considered an employee for federal income tax purposes. A worker may be classified as an employee even if some, but not all, of the factors are applicable.

Statutory Nonemployees

Some licensed real estate agents and direct sellers (door-to-door) are classified as statutory nonemployees. If a worker has been mistakenly classified as an independent contractor, the employer faces a dilemma. The employer can reclassify the worker as an employee and risk being audited and owing back income, social security and medicare, and FUTA taxes, penalties and interest. If the employer does not immediately reclassify the worker, the employer may face even greater penalties the longer the delay in treating the worker correctly.

Filing Requirements for Employees and Independent Contractors



Independent Contractor

Register for filing detailed payroll information



Withhold federal income tax



Withhold employee’s share of social security and medicare



Employer’s share of social security and medicare



Employer’s FUTA and SUTA tax



Quarterly reportingForm 941



Annual reporting

Form W-2



Form 940



Form 1099-MISC



Offer employee benefits



The IRS 20 Factor Test

An individual is generally considered an employee rather than an independent contractor by the IRS if the worker . . .

  1. Must comply with company instructions about when, where and how the work will be performed.

  2. Receives training from or at the direction of the company.

  3. Performs "ordinary and necessary" business activities.

  4. Does not retain the right to delegate work to an assistant or subcontractor.

  5. Is aided by assistants hired, supervised and paid by the company.

  6. Has a continuing relationship with the company.

  7. Works a schedule set by the company.

  8. Works full-time for the company.

  9. Works on company premises.

  10. Performs duties in an order set by the company.

  11. Must submit regular reports to the company.

  12. Is paid in set amounts at regular intervals.

  13. Receives payments for business and travel expenses.

  14. Uses a significant number of company- provided tools and materials.

  15. Has little or no investment in the resources required to perform work.

  16. Cannot make a profit or suffer a loss from the services provided.

  17. Does not work for more than one company at one time.

  18. Does not consistently seek work from general public.

  19. Can be fired for reasons other than failure to produce results specified in a contract.

  20. Can quit at any time without incurring liability.

(If a number of these statements apply, the worker is probably an employee).



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