What makes one worker an employee and another not an employee? It can be confusing to determine which is which. But, it’s essential that you understand the difference. So, let’s take a look at who is an employee.
Who is an employee?
An employee is someone you hire and pay for their work, which you use to benefit your business. But, not all workers you hire and pay are employees. You must determine the worker’s classification.
When you are determining a worker’s status, you must consider your control over them. If you have great control over the worker, they are probably an employee. To help you examine control, you can use a three-part test from the IRS called common law rules. The three parts are explained below.
Behavioral control: Do you control or have the right to control what the worker does and how the worker does their job? If so, the worker might be an employee.
Financial control: Do you control the business aspects of the worker’s job? This includes things like how the worker is paid, whether expenses are reimbursed, and who provides tools and supplies. If you control business aspects, then the worker might be an employee.
Type of relationship: Are there any written contracts or employee type benefits? These include things like retirement plans, insurance, and vacation and sick pay. Will your relationship with the worker continue? Is the work performed a key aspect of your business? If you answered yes to these things, then the worker might be an employee.
You must consider all three parts of the test. One factor doesn’t weigh more than the others. Also, there is not a set number of factors that a worker needs to meet to be considered an employee. For example, a worker might only meet two parts of the test and still be classified as a common law employee. Use your best judgment.
Confusing, right? If you go through the three parts of the common law rules and still aren’t sure how to classify the worker, you can get help. File Form SS-8 with the IRS. The IRS will then determine the worker’s classification for you. Also, your state might have rules that are stricter and clearer than the federal government’s rules, so make sure you check with your state department of labor.
Employee hours
The number of hours someone works does not matter when determining if someone is an employee. You can have full-time, part-time, and temporary employees. Employees might work a few hours or many hours per week. And, they might work for your business for years or as little as one day.
The opposite of an employee
So if a worker isn’t an employee, then what are they? Workers who are not employees are classified as independent contractors.
An independent contractor is someone who runs their own business and performs work for another business. You don’t have behavioral, financial, or relational control over the contractor.
The importance of correctly classifying employees
You do not want to mix up employees with contractors. There are important differences and implications for not classifying correctly.
You need to know the definition of an employee for tax purposes. With employees, you must withhold the following taxes from their wages:
- Federal, state, and local income taxes
- Social Security tax
- Medicare tax
As the employer, you must also pay employer taxes based on the employee’s wages. These taxes are:
- Social Security tax
- Medicare taxes
- Federal and state unemployment taxes
Contractors pay their own taxes. You will not withhold taxes from contractors’ wages.
When you have employees, you must also pay for insurances. This might include workers’ compensation insurance and state disability insurance.
You will likely provide benefits to employees. These might include retirement plans, health plans, commuter benefits, and sick pay. You will not give benefits to contractors.
If you misclassify an employee as an independent contractor, there can be repercussions. The worker might have missed out on wages. And, you wouldn’t have withheld or paid taxes on the wages. You might owe back wages and taxes, interest, and penalties.
When you have employees, you need to run payroll. Check out Patriot Software’s easy-to-use, online payroll software for small businesses. It uses a simple three-step process to make payroll quick to complete. Get your free trial today!
This article is updated from its original publication date 8/15/2018.
This is not intended as legal advice; for more information, please click here.