May 8, 2019 / by Fortis Family Office Tax Team
Before you can determine how to treat payments you make for services, you must first know the business relationship that exists between you and the person performing the services. The person performing the services may be ¹
- an independent contractor
- an employee (common-law employee)
- a statutory employee
- a statutory nonemployee
How You Pay a Worker Determines How a Worker Pays Taxes
An employee can be paid hourly or salary with bonuses/paid commission. Employees are taxed on their income and you are required to withhold federal and state income taxes (depending on their state income tax laws) and FICA taxes.
If you are paying an independent contractor, you are not required to withhold federal or state income taxes or FICA taxes. The independent contractor must pay his or her own income taxes (called self-employment taxes), along with income tax on earnings. ³
Also, most employees receive an annual Form W-2 and an independent contractor Form 1099-MISC, which are important when filing income taxes.
How the IRS Determines a Workers Status
If you are unsure how to determine a workers status, consider the three categories the IRS set up as a guideline for employers. The three categories are –
Behavioral Control – a worker is an employee when the business has the right to direct and control the work performed by the worker. The behavioral control factors fall into the categories of ²
- type of instructions given
- degree of instruction
- evaluation systems
Financial Control – refers to facts that show whether or not the business has the right to control the economic aspects of the worker’s job. The financial control factors fall into the categories of ²
- significant investment
- unreimbursed expenses
- opportunity for profit or loss
- services available to the market
- method of payment
Relationship – the type of relationship depends upon how the worker and business perceive their interaction with one another, such as, written contracts, benefits, services provided and the permanency of the relationship. ²
To avoid misclassifying a worker you can exercise due diligence. It is important to know the difference of each workers status and to know how to properly withhold taxes.