Employees Vs Independent Contractors (Part 2)

In this blog, I'm going to dive deep into both the IRS rules and the state-related rules plus all the potential business implications of choosing one or the other. The number one most common misnomer is business owners think that this is choice business owners make or employees make.

It is part of the Complete guide will be in three parts, we covered in Part 1, why this matters and what are the motivations of either an employee or a business to be classified as an employee or contractor. We're going to talk about the business requirement when working with an independent contractor. Then some of the tips I give to my clients about how to deal with independent contractors in Part 3.

That's not true there's a specific set of rules that determine whether or not the employee or the worker is going to be classified as one or the other so we're a deep dive into that now even though. I think I give pretty good tax advice. I would strongly recommend that you work with your CPA. When it comes to any specific tax questions that pertain to your business also if there are legal questions you should never take CPA advice. You should always take a lawyer's advice on that.

IRS Rules

Now let's move on to IRS rules because this is as I mentioned earlier this is not a choice. It's not oh! I choose to be an employer or choose to be an independent contractor. The business chooses to pay them as a 1099 contractor it doesn't work that way. You have to follow specific rules and figure out based on the rules how to determine what that worker status is.

So IRS rules are broken down into three categories:

1.    One behavioral control
2.    Financial control 
3.    Relationships or type of relationship

so let's go deep into each one of these behavioral control so a worker is an employee when a business has the right to direct or the control performed by the worker so some examples are a type of instructions given.


So it's that employer or is that business giving them specific instructions. On how to do the work, how to perform the work, what tools to use that sort of thing.


Is the degree of instruction so if you have an independent contractor you have to tell them more or less. What you want and how you want it but if you give them to detail how to and have specific requirements. How they're gonna perform every part every task of their job, that's gonna gear more towards employee versus independent contractor.


Now evaluation system are you evaluating that employee you evaluating their efficiency their productivity are you doing annual reviews are you doing monthly reviews are you doing six-month reviews are you treating that person as an employee where you're evaluating what they do and hardly do it every single time if you're doing that, that makes gear more tip to scale more towards the employee.


Are you training so are you training them specifically. How to do the job? Now showing them once how to do it and then letting them finish. That's generally okay but having these ongoing training and ongoing quality control it's probably gonna tip the scale more towards employees versus in the pen contractor.

Financial Control

Does the business have financial control or control over the financial aspects of the worker’s job? so for example is a business investing in equipment right in the tools that the worker uses.


What is significant enough or is it pretty certain that most of the equipment. The vast majority of the equipment or the principal equipment that the worker is using is paid for or financed by that employer. If that's the case it will tip more towards employees. What about unreimbursed expenses so typically an employee if they have to pay it all or they have to pay for something on behalf of the business or their employer they're gonna get reimbursed.

Independent Contractor

We're independent contractors who typically give a contract price or the actual rate for the job. All the expenses are incurred by them and that's their problem right, their expenses as an own issue that had to keep control.  It's all sort of implied within the contract that all those expenses are going to be paid for by the independent contractor.


Now some contracts made a call for specific out-of-pocket unreimbursed expenses and that's okay. But generally speaking, most employees get unreimbursed expenses refunded and workers or independent contractors do not know the opportunity for profit or loss. If you're an independent contractor you should be able to lose if you screw up. If you have to do it twice. 

In other words, the contract said this is the final work (price regardless) of what it costs that independent contractor to do it. They must complete it or be contractually obligated to complete it with an employee. Typically if the employer screws up they'll just keep working and do it again.

Payment Method

Typically they get paid by the hour anyway or they get a short paycheck no matter what. So most of the time employees don't lose on any sort of employer-employee transaction.

Now their services available to the market in other words does that independent contractor offer this to other people as well right if they're exclusive and you as the business is the only business. That independent contractor works for that's gonna tip the scale more towards employees.

If the independent contractor works with several businesses offers similar services to the competition potentially. That's gonna tip the scale more towards independent contractors and methods of payment.

So is that person being paid weekly at the same time as all the employees with the payroll checks? are they being paid by the hour are they turning in timesheets? if that's the case that tips the scale towards employees. If you were paying the independent contractor based on the invoice, based on the job, based on the contract, at tipsy scale more towards the independent contractor, not a relationship.


Now, what about the relationship so the type of relationship that an employer and worker have mattered. So for example, their executed contracts are written contracts. An independent person could go back and look at it and say yeah this shows that these are two independent parties doing business with each other.

Number One

That employer paying employees like benefits to that independent contractor is being invited to the team meetings are they being invited to the end-of-the-year meetings? all those things matter. when it comes to that relationship.

Number Two

Now the permanency of the relationship is important. So it's just a short-term contract or I said implied they'll be doing business with each other forever. All year long so if it's a short-term contract. It's implied that it's not a permanent relationship here in York's work exclusively for me. 

Work with me forever then it tips more towards independent contractors.  If it's a sort of a relationship that's forever a career type of relationship. That's gonna tip the scale a lot more towards I employee and then.

Number Three

Finally, you know the services provided the key activity of the business. So a restaurant couldn't have a cook or a server as an independent contractor even if it's for one day. Because cooking the food and serving the food. It's a key part of running that business. So typically you have independent contractors do extraordinary work not the key services of that business. 

This is probably one of the ones that get abused the most. Because most of the time anyone you hire as a business owner there's a key thing regarding and some subjectiveness to what's right what's important what's the principle service. That the business provides but this was a bit more subject to scrutiny.

But again you're gonna have to weigh in all of these things right financial control behavior control relationship control. It doesn't have to be all of these; they're just all considered at the same time now there's a form that you can download in the IRS form ss8.

It's called the termination of worker status for federal employment taxes and income tax withholding. You can download it right off the IRS website. I'll put a link in the description below that is the actual form that the IRS would use to investigate a classification issue. 

For example, we have an independent contractor that calls the IRS and says hey this person's treating me as an independent contractor. Although they're an employee and they'll start an investigation they'll require them to send the SSA form filled out.

It's got several pages, many many questions in there, and both parties all the parties involved have to fill out the form, and then a third party, an impartial person will look at them. Then determine whether you know one smells more like an employee or smells more like an independent contractor.

It starts from here, so if you have any doubts about what the IRS is gonna think about this specific worker. You can look at the form and just sort of answer them on your own and see whether your answers tip the scale more towards an employee or independent contractor.