Article
3 min read
Author
Anja Simic
Published
September 28, 2021
Last Update
July 03, 2024
Table of Contents
Who is considered an independent contractor
The Reasonable Basis test
The IRS 20-Factor test
When hiring a person, it is vital to determine whether the person can be classified as an independent contractor or an employee. Many factors determine that, which we discussed in the contractor vs employee article. In this guide, however, we will focus on the IRS 20 Factor Test and how it can help employers and employees understand the worker status and classify it correctly.
An independent contractor is a service provider who agrees with an employer to provide requested services on a need or project basis. This individual is not directed or controlled by the employer regarding the performance of their work.
Independent contractors have greater control over how and when they carry out their work compared to employees. Companies don't provide payments for the worker's business expenses, just a lump sum fee for their services.
Various laws apply to the employer-employee relationship that are generally not applicable to independent contractors. Pension, workers' compensation, social security, and wage and hour law are some of the things that cannot be offered to an independent contractor. However, independent contractors can be awarded a bonus. When it comes to tax withholding, employees are not obliged to withhold federal, state, and local taxes. Independent contractors are usually responsible for filing their own taxes.
There are many benefits to the independent contractor relationship, but every company must determine if this relationship is applicable carefully. The risk of misclassification is tremendous and can result in back taxes or premiums, civil fines, interest, and other retroactive damages.
The IRS created guidelines to help employers to classify their employment relationships correctly. The IRS follows the common law test when determining whether an individual is an employee for federal employment tax purposes.
The "Reasonable Basis" test serves as an excellent tool for employers, which prevents the IRS from challenging the status of an individual as an independent contractor if certain conditions are met. In that case, the employer does not have a tax liability for workers under Section 503, and the IRS cannot penalize them for misclassification.
The IRS designed the 20-Factor Test to help employers assess whether a worker is considered an employee or an independent contractor. No one factor is more important or indicative of employee status. It would be best if you looked at things holistically. If there are more "Yes" answers than "No," then there is a significant risk of employment relationship presence.
If an employer is unsure even after taking the test, we advise pursuing the IRS ruling. This is done by filing a Form SS-8 (Determination of Employee Work Status for Purposes of Federal Employment Taxes and Income Tax Withholding) to the IRS.
Disclaimer: This article has an informational purpose only and is not meant to replace legal advice or act as IRS connected service. Before you make any final decisions, check the IRS website for the latest information.
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