Working Relationship Status: It's Complicated

Working Relationship Status:

Ο  Employee

Ο  Independent Contractor

⊗  It’s Complicated

“The law does not define an independent contractor.”

                                                     – NYSDOL – Independent Contractors.

“To determine whether an individual is an employee or an independent contractor under the common law, the relationship of the worker and the business must be examined.”

                                                     – IRS Publication 15-A, Employer’s Supplemental Tax Guide

When was the last time you tried to define a relationship? Not a simple task. Even Facebook has a relationship category for “It’s Complicated”! It would be so much better if there was a clear definition we all could follow. So how do we examine the relationship between a worker and a company paying them for service? And who has the final say?

To begin, let’s start with the results of the classification. To do that, we simply follow the money. The IRS Publication 15-A tells us “An employer must generally withhold federal income taxes, withhold and pay over social security and Medicare taxes, and pay unemployment tax on wages paid to an employee.” Sometimes referred to as a W-2 Employee, this worker is the most common. They work, they get paid, they go home. At the end of the year their employer sends a W-2 form to both the worker and the IRS, reporting the employee’s annual wages and the amount of taxes withheld from their paycheck. A W-2 employee is also covered with Workers’ Compensation Insurance in case of a work related injury and Unemployment Insurance when the job comes to an end.

An Independent Contractor, on the other hand, is not only responsible for their own reporting and invoicing, they are also responsible for all taxes. The company pays each invoice and at the end of the year provides a 1099 form. A 1099 form serves a similar purpose to an independent contractor as a W-2 does for an employee. The form reports the total amount of payments received from a single person or entity during the year that services were provided. And since the IRS considers any 1099 payment as taxable income, the worker is required to report any and all 1099 payments on their tax return as well as pay all applicable taxes. And if they did not set aside the proper amount from each 1099 payment, this could be a difficult task. In addition, Independent Contractors typically have no Workers’ Comp Insurance and are ineligible for Unemployment Insurance.

Working our way backwards, it is important next to know who has the final say in this classification. Unfortunately, it is not the worker and it is not the company paying for the service. That leaves the government. The NYSDOL specifically states “If an employer designates a worker as an independent contractor and the worker agrees, it does not mean the worker is an independent contractor under the law.” Furthermore, “Failure to report earnings and pay contributions due on the earnings of persons on the assumption that they are an independent contractor may result in additional assessments and interest if they are later determined to be employees.” Let me repeat that in plain English. Just because the worker and the company agree on an Independent Contractor status, doesn’t mean they are. And if the company gets caught, it will cost extra. Clearly the government prefers all workers to be employees, and not independent contractors. Because of that, rarely do you have to prove someone is an employee. That is the preferred and default classification of a worker. Instead you must go to great lengths to prove someone classified as an independent contractor is not an employee. Good luck.

In general, Independent Contractors A) are in business for themselves and make their services available to the public and other organizations and B) perform services free from supervision, direction, or control. With regard to control, three categories of facts are considered: behavioral control, financial control, and the type of relationship of the parties. A company doesn’t even have to actually provide supervision, direction or control to be considered an employer.  If the employer provides, or has the right to provide, supervision, direction or control, an employer-employee relationship exists. It does not matter if the services are full time, part time, or on a casual basis. For more detail, refer to the NYSDOL and IRS publications mentioned at the beginning of this article.

Bottom line? BE CAREFUL. If you choose to pay workers as independent contractors, understand that there is more to it than simply getting their buy-in. You must also be able to defend your position against government entities that want very much to have them classified as employees. It is worth noting that both the IRS and NYSDOL provide avenues to request a determination of whether or not a worker is an employee. You can file Form SS-8 with the IRS, or write to the Liability and Determination Section of the NYSDOL.