Are you an employee or an independent contractor? It's important to know the answer because it has a huge impact on your taxes, among other things. The Internal Revenue Service (IRS) has detailed guidelines to help you determine the difference. Here are some frequently asked questions about taxes for independent contractors.
- What do I do if I still can't determine whether I'm an employee or an independent contractor after looking at all the evidence?
Q: How do I know if I'm an employee or an independent contractor?
- A: Independent contractors are in business for themselves, while employees work for other peoples’ businesses. The IRS and many other government agencies use the “right of control” test to make this determination. Under this test a worker is an employee if the hiring firm has the right to control the way the worker performs on the job, both as to the final results and the details of how the work is performed. A worker is an independent contractor if the hiring firm's control is limited to accepting or rejecting the final results the worker achieves. The IRS looks at all relevant factors to make this determination. These fall into three main categories: behavioral control, financial control, and the relationship of the parties. For you to be an independent contractor, the factors that show lack of control must outweigh those that indicate control. No one factor alone is enough to make you an employee or an independent contractor.
Q: What factors fall into the behavioral control category?
- A: These are factors that show whether the hiring firm you're working for has the right to control what you do and how you do it. For example, you are more likely to be viewed as an employee by the IRS if the hiring firm has the right to give you instructions you must follow about how to do your work, or if it gives you detailed training.
Q: What factors fall into the financial control category?
- A: These are factors that show whether the hiring firm has the right to control your financial life. This includes how you're paid, whether you provide your own equipment and facilities, and whether your expenses are reimbursed by the hiring firm. Unlike employees, independent contractors have a risk of loss—for example, because they have a significant investment in their business, pay their own expenses, or are paid by the job.
Q: What factors fall into the "relationship of the parties" category?
- A: These are factors that show whether you and the hiring firm believe that you are an independent contractor rather than an employee. This includes whether you have a written independent contractor agreement, whether you receive employee benefits, and whether your relationship is considered permanent or you can be fired at any time.
Q: What do I do if I still can't determine whether I'm an employee or an independent contractor after looking at all the evidence?
- A: The IRS can help you out. You can complete and file with the IRS Form SS-8, Determination of Worker Status for Purposes of Federal Employment Taxes and Income Tax Withholding. The IRS will use your answers on this form and the results of its own investigation to determine if you should be classified as an employee or contractor. The IRS’s determination is not binding on the hiring firm, although it is binding on the IRS.
Q: What happens if my company incorrectly determines that I'm an independent contractor?
- A: The company may have to pay the employment taxes it failed to withhold from your paychecks and reimburse you for half the payroll taxes it should have paid on your behalf as your employer. It may also be liable for interest and penalties. Your can file IRS Form 8919, Uncollected Social Security and Medicare Tax on Wages to figure and report your share of the uncollected Social Security and Medicare taxes due on your compensation while you were treated as an independent contractor instead of an employee. However, being reclassified as an employee is not necessarily all good for you. It could result in the loss of valuable business deductions you claimed on your taxes in prior years.
Q: As an independent contractor, what form do I file with the IRS to report my income?
- A: You report your income on Form 1040, Schedule C, Profit or Loss from Business (Sole Proprietorship) or the shorter Form 1040, Schedule C-EZ, Net Profit from Business (you may use this simpler form only if you had expenses of no more than $5,000), which you file with your annual federal tax return. You list all of your business income and expenses on this form to determine your annual net profit or loss from your independent contractor business.
Q: How do I pay Social Security and Medicare tax if I'm an independent contractor?
- A: Employees have their Social Security and Medicare taxes withheld and paid to the IRS by their employers, who must also make matching contributions. This is not the case when you're an independent contractor—you must pay all of these taxes yourself and they are not withheld by the hiring firms you work for. Instead, you must pay them directly to the IRS along with your federal income taxes. To report and pay these taxes, file Form 1040, Schedule SE, Self-Employment Tax along with your federal income tax return.
Q: Do I have to make quarterly estimated tax payments if I'm an independent contractor?
- A: Yes. Independent contractors are not allowed to wait until they file their annual tax return to pay all the tax they owe for the prior year. Instead, you must pay your taxes in advance throughout the year in the form of four estimated tax payments. These payments must include both income tax and Social Security and Medicare taxes. Use Form 1040-ES, Estimated Tax for Individuals, to help you determine the amount of your payments.