Sub-contractor vs. Employees

Sub-contractor or Employee?

For many companies deciding whether there relationship is an employee or subcontractor may seem daunting. There are advantages to both relationship but if you classify incorrectly it could cost you a lot of money and some have even lost their business. While this article is not intended to answer all questions or be the final authority I do hope to shed some light on this subject.

To begin with the IRS and state workers compensation insurance can come up with two different answers for the same employee/subcontractor. With this being said the unemployment auditor’s decision will vary from state to state and auditor to auditor. However for the purpose here we are only going to look at the IRS and their methods for determining employee vs. sub-contractor.

To begin with at the simplest level “an individual is an independent contractor if you, the person for whom the services are being performed, have the right to control or direct only the result of the work and not the means and methods of accomplishing the result.” IRS Pub 15-A PG 3. Essentially this means if you can control how and when services are done there is an employee relationship. Even if you don’t enforce that right if you do have the right to control the how and when the employee relationship exists. The IRS is concerned with the SUBSTANCE not the label. The obvious advantage for the sub-contractor status is that the person for whom the service is being performed is not liable for payroll taxes and possibly unemployment taxes. And this is the reason that the relationship is often challenges by state and federal agencies.

The IRS under common law has a set of tests to decide whether an individual is an employee or sub-contractor. They are divided in to three groups: Behavioral control, financial control, and type of relationship of the parties. We will go through these at this point.

Behavioral

1) Instructions - there tends to be an employee relationship when a worker is subject to a company’s instruction about how a job is to be done.
2) Training – An independent contractor will not normally need to be trained.

Financial

1) Unreimbursed Expenses – Employees will generally have fewer unreimbursed expenses than a sub contractor although employees can have unreimbursed expenses.
2) Investment – An independent contractor will generally have invested money into their company in order to perform their service.
3) Services available to the general public – An independent contractor will often seek out additional business through advertising and are available to work for others.
4) Pay – An independent contractor will generally be paid a flat fee based on the individual job. However some professions such as accounting and law bill hourly.
5) Profit and loss potential – An independent contractor has the potential to make a profit or suffer a loss.

Relationship

1) Written Contracts – An independent contractor will generally have a signed contract for work to be done.
2) Benefits – An independent contractor will generally not receive benefits.
3) Time of engagement – An independent contractor will generally be engaged for specific time frame. An indefinite period tends to resemble an employee relationship.
4) Workers business the same as your key business – If the worker provides a service that is the same as you business it lends itself to more of an employee relationship. Ex - A painting contractor that hires a worker in a painter capacity. This does not of itself mean that the worker is an employee but it may be an indication.

While you do not have to pass every one of these tests these are the basis by which the relationship is decided. If you have a situation that you are not sure of it would be best to contact you CPA to have them help you decide what is the best classification in your situation. If you are still not sure you can file a Form SS-8 with the IRS and they will determine it for you. However the vast majority of filed SS-8’s are returned as an employee. For further infromation refer to the IRS's website at www.irs.gov.

The information contained on this site should in no way be considered to be professional advice in the form of either tax, accounting, or legal service or consultation. You should always consult with a professional familiar with your individual circumstances before making any specific decisions related to accounting, tax, or legal matters.