Employee or independent contractor? How the IRS looks at it

Paying someone on a Form 1099 can feel simpler than putting them on payroll, but the label you choose does not decide the question. The IRS looks at the actual working relationship. See IRS Topic no. 762 for its explanation.

The three areas the IRS reviews

• Behavioral control: do you have the right to direct how the work is done, through instructions or training?
• Financial control: who controls the business side of the job, such as tools, expenses, investment and how the worker is paid?
• Type of relationship: is there a written contract, are employee-type benefits provided, and is the relationship ongoing?

Two examples (illustrative)

Likely an employee: a warehouse worker who comes in on a schedule you set, uses your equipment, follows your procedures and has worked for you for two years.

Likely a contractor: a graphic designer who works for several clients, uses her own software, sets her own hours and invoices you for each project.

These are simplified. Every situation depends on its facts.

Step by step: reviewing a worker

1. List everyone you pay on a Form 1099.
2. For each person, answer the three questions above.
3. Collect a Form W-9, a written agreement and invoices from true contractors.
4. If you are unsure, get advice. The IRS also lets you request a determination using Form SS-8.
5. If a worker should be an employee, set them up on payroll.

Why it matters

An employer who treats an employee as a contractor without a reasonable basis can become liable for employment taxes, along with penalties and interest.

Need help? See our payroll services or use the checklists to prepare your records.

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