Employee or Independent Contractor?

As a general rule, your obligation to withhold and to pay payroll taxes applies to any workers you have who are properly classified as being employees as opposed to independent contractors. Only in rare circumstances will a business be relieved from payroll tax obligations with respect to employees or be responsible for payroll taxes with respect to your independent contractors.

For payroll tax purposes, the IRS and the various state tax agencies rely on so-called common law rules to distinguish employees from independent contractors. Under these rules, your workers are employees if you have the right to direct and control them in the way they work, both as to the final results and as to the details of when, where, and how their work is done.

The important issue here is whether you have the right to control your workers' activities. Even if you grant your workers considerable discretion in determining how they do their work, as long as you retain the legal right to control their activities, the workers are common-law employees.

Obviously, there are innumerable ways in which you can exercise control over a worker. And, by no means is there a clear definition of just how much control on your part is enough to cause a worker to be classified as an employee rather than an independent contractor. Rather, each case depends on an analysis of its own particular set of facts. To help you with this analysis, the IRS has devised several aids:

 
Warning

A common misconception among new employers is that they can avoid incurring payroll tax obligations simply by having their workers sign agreements that declare the workers to be independent contractors. Such self-serving agreements carry little, if any, significance under the common-law rules. If your actions show an employer-employee relationship, then your workers are employees regardless of how you choose to describe them.

Special rule for the securities industry. A special law provision states that in determining the status of a registered representative of a securities broker-dealer, no weight is to be given to instructions from the broker-dealer which are imposed only to comply with government or governing body investor protection standards. The law states that while it is effective as of December 31, 1997, no inference is intended that it has not always been the correct conclusion.