How To Tell If You’re Paying A Freelancer Or An Employee

You know the people who work for you, right? I know you do. What about the IRS? That, as a matter of fact, could be a major headache down the road. Smaller businesses usually give their employees (E) plenty of work to do, and some rely on independent contractors (IC) or freelancers (F) to handle certain tasks or temporary work. These types of people aren’t considered “employees,” right? Watch out: It could be the opposite.

Astonishingly, the technical definition of an IC or E doesn’t concern the time that person puts in for the business, or how much or how often they are paid. The deciding factor is how much power the business has over that person’s activities. Usually, if you have power over the end result of the work, by signing off or returning a completed project, then the person is an IC. However, if you also have power over the completed project, and how and when it is produced, then the person is an E. So, if a mechanic spends his days working in your shop, uses his own stuff, works on his time, and isn’t under any type of supervision, then that person is an IC. But, on the other hand, if he works with your tools and miscellaneous equipment, on your clock, and is told what to do by managers while he works, then that person is an E.

Knowing the difference between IC and E is pretty important when you’re an employer. For Es, it means you are required by law to withhold income taxes from their pay, plus Medicare, social security, and so on. On the other hand, you don’t have to worry about taxes on money given to ICs. If you falsely classify an E as an IC, the IRS will make you pay for that person’s unpaid taxes as well as penalties and incurring interest. If the IRS determines that you have wrongfully classified an employee, you will have to pay back taxes and penalties for every year of that mistake.

Motivated by tax errors, the alphabet boys closely look at people whose income is reported on 1099 forms, with an owl’s eye on companies who list their Es and ICs. If your mechanic receives most of his income from one company, the IRS will look into it and see if he is a genuine IC. This will probably create a major headache for you, especially if you find out your mechanic should have been an E all along.

If you have a hard time understanding the difference between an E and an IC, or you make sure you don’t step on the alphabet boys’ toes, you can end your worries by submitting the SS-8. All it really asks you is that you describe the type of work for your employees, the level of supervision, and pay. You can check out official publications talking about the specific rules that determine the difference between Es and ICs here.