Distinguishing between an employee and an independent contractor lies on a thin line of control. The IRS defines this control by utilizing three categories: behavioral control, financial control, and the type of relationship.
As an employee, an individual is entitled to certain benefits that an employer generally guarantees such as health care, pension plan, or vacation pay. The employer also pays one-half of the employee’s employment tax, including the social security tax. If a business is to misclassify an employee as an independent contractor, they would be able to avoid paying those employment taxes. Section 530 of the IRS Tax Code provides businesses a path to opt out of the employment tax if they fulfill certain requirements. To be eligible for the 530 relief, businesses must report tax returns consistently, maintain substantive consistency of how the workers are treated, and possess reasonable bias for not treating said workers as employees.
To simplify it, independent contractor is a fancy word for freelancer. An independent contractor will provide a service to a business, but still retain autonomy. Independent contractors are responsible for their own supplies and equipment, have the ability to choose their hours, and usually perform temporary work. Independent contractors are also responsible for their own “self-employment tax” which includes the full amount of social security taxes.
Whether an independent contractor can have a permanent role in a company while continuing to not be defined as an employee is a case by case determination. The difference between the two becomes blurred in long term relationships. There is no clear rule, so it is necessary to defer to the other guidelines spelled out by the IRS in a form called a SS-8, Determination of Worker Status for Purposes of Federal Employment Taxes and Income Tax Withholding.
If a company classifies an employee as an independent contractor and has no reasonable basis for doing so, the company will probably be held liable for employment taxes for that worker. Some companies misclassify due to lack of knowledge. Other companies deliberately misclassify to avoid paying employment taxes. If the IRS questions your company’s classification, it is best to hire an attorney. Better yet, hire the attorney prior to making the classification so your company does not run afoul of IRS regulations.