There is a lot of confusion about what constitutes an independent contractor. The general rule is that certain professions are often independent contractors. Professions such as lawyer or accountant that offer their services to the general public are generally viewed by the IRS as independent contractors. These professions provide services to several different clients as opposed to an in-house counsel or accountant than only works for one company: their employer.
The IRS, though, takes a fact-specific review in determining who classifies as an independent contractor. Their general rule is that an individual is classified as an independent contractor when the person paying the contractor has the ability to control or direct only the result of the work, but cannot control what and how the work will be done. Take the example of hiring a lawyer. The person hiring the lawyer wants a contract drafted (the end result) but the person hiring has no ability to control how and what the contract is drafted.
On the other hand, an attorney that has an employer-employee relationship is likely not an independent contractor. The lawyer is employed by DTE Energy, for example. This attorney only represents DTE, and does not work for any other employer or hiring person. Thus, since DTE controls both the result of the attorney’s work, and also controls what and how the work will be done, the attorney is an employee and not an independent contractor.
When the determination is unclear, the IRS uses the following test:
- Behavioral: Does the company control or have the right to control what the worker does and how the worker does his or her job?
- Financial: Are the business aspects of the worker’s job controlled by the payer? (these include things like how worker is paid, whether expenses are reimbursed, who provides tools/supplies, etc.)
- Type of Relationship: Are there written contracts or employee type benefits (i.e. pension plan, insurance, vacation pay, etc.)? Will the relationship continue and is the work performed a key aspect of the business?
These are the main factors the IRS reviews when determining whether someone is an independent contractor or an employee. If you are hiring, consider these factors in determining what classification you should use.
This classification has ramifications for tax reporting. For example, an independent contractor is subject to self-employment tax. An employer is required to withhold incomes taxes and Social Security and Medicaid taxes. It also has ramifications for certain laws, such as the Affordable Care Act and Family Medical Leave Act.