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Depending on the nature of your business, you may benefit more from having someone work for you as an Independent Contractor rather than as an employee.
Of course, in order to do that you have to understand the difference between the two. The question of whether a worker is an independent contractor or employee for federal income and employment tax purposes is a complex one. It is intensely factual, and the stakes can be very high because businesses carry a large tax burden for employees.
Some owners will assume that a part-time worker is automatically an independent contractor. However, the IRS can reclassify workers as employees and then demands back taxes, interest and penalties; wreaking havoc on a business’s cash flow.
Avoiding this situation can be tricky. There is no specific definition of an employee from a tax perspective. Courts have ruled that someone is an employee if the company he works for has the right to control and direct him regarding the job he is to do and how he is to do it. Otherwise, he is considered an independent contractor. That’s why it is so important to determine what is considered control. However, that is just the beginning.
If you determine that a worker is, in fact, an independent contractor, you may still run into problems. The Internal Revenue Code contains definitions for individuals who are considered “statutory employees.” These individuals are treated as employees for social security tax purposes even if they aren't subject to an employer's direction and control, to wit, a court would find these workers to be independent contractors. Examples of such workers are agent drivers and commission drivers, life insurance salespeople, home workers, and full-time traveling or city salespeople who meet a number of tests. Statutory employees may or may not be employees for non-FICA purposes. Corporate officers are statutory employees for all purposes.
Individuals who are statutory independent contractors (that is, specifically identified by the tax code as being non-employees) aren't employees for purposes of wage withholding, FICA or FUTA, and the income tax rules in general. These individuals are qualified real estate agents and certain direct sellers.
Sufficiently confused? If you are using more than a few individuals that you wish to classify as independent contractors, you should get an opinion letter from your tax professional supporting you. If the IRS comes calling, such a letter can be used to support your position as well as argue for leniency.
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