Mangrove Tax and Accounting

Employee v Subcontractor

One of the reoccurring issues faced by business owners is whether or not someone is to be treated as an employee or a subcontractor. Often times the decision is clear: the business hires a full time secretary who will work 40 hours per week at a specific pay rate and that person is covered under the businesses health insurance plan; or a part-time line worker is hired for 25 hour per week during the busy season, and that person will only receive partial benefits.

Other times the distinction is not quite so clear, suppose the business is going to hire someone to clean the office. This person will have after- hour access to the business location and be expected to come on a daily basis to clean. Is this person an employee or a subcontractor? The answer is . . .it depends. There are a number of factors that need to be looked at.

According to the Internal Revenue Service, for federal employment tax purposes, the usual common law rules are applicable to determine whether a worker is an independent contractor or an employee. Under the common law, you must examine the relationship between the worker and the business. All evidence of the degree of control and independence in this relationship should be considered.
The facts that provide this evidence fall into three categories – Behavioral Control, Financial Control, and the Relationship of the Parties.

Behavioral Control covers facts that show whether the business has a right to direct and control what work is accomplished and how the work is done, through instructions, training, or other means.
Financial Control covers facts that show whether the business has a right to direct or control the financial and business aspects of the worker’s job. This includes:

• Does the worker have unreimbursed business expenses?
• Does the worker have an investment in the facilities or tools used in performing services?
• Does the worker make his or her services available to the relevant market?
• How is the worker paid?
• Can the worker can realize a profit or incur a loss?
• Does the worker provide service under a business name?

Relationship of the Parties covers facts that show the type of relationship the parties had. This includes:

• Written contracts describing the relationship the parties intended to create
• Whether the business provides the worker with employee-type benefits, such as insurance, a pension plan, vacation pay, or sick pay available to other workers
• The permanency of the relationship
• The extent to which services performed by the worker are a key aspect of the regular business of the company

The Internal Revenue Service has been known to come back and reclassify subcontractors as employees. This can create a paperwork nightmare for a small business, resulting in the need to amend 941 and 940 forms as well as prepare additional W-2 forms. It can also create financial hardships for an organization as it will have to pay all payroll taxes as well as interest and penalties. It will also create a problem for those businesses located in states with state level employment taxes. Those reports will need to be changed and any additional monies paid.

As you can see, the answer to the employee vs. subcontractor decision is not an easy one. It is important to examine each situation thoroughly.