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December 17, 2017

Small Business Advice

Does the IRS view your sub-contractors as independent contractors or employees?

Gray Poehler | 8/21/2017

Q: I am a general contractor and uncertain how the Internal Revenue Service will view my relationship with sub-contractors. Are they regarded as independent contractors or my employees?

A: The question of who is an independent contractor seems to be a constant source of confusion among many small business owners. One notion is that if an individual signs an independent contractor agreement, the general contractor or employer has nothing to fear from the Internal Revenue Service. Such an agreement is not worth the paper it’s written on unless it meets certain criteria established by IRS.

But in answer to your question, allow me to quote excerpts from the IRS web site.

Generally, you must withhold income taxes, withhold and pay Social Security and Medicare taxes, and pay unemployment tax on wages paid to an employee. You do not generally have to withhold or pay any taxes on payments to independent contractors.

In determining whether the person providing service is an employee or an independent contractor, all information that provides evidence of the degree of control and independence must be considered.

 Facts that provide evidence of the degree of control and independence fall into three categories:

  1. Behavioral: Does the company control or have the right to control what the worker does and how the worker does his or her job?
  2. 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.
  3. 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?

Also, does the worker provide similar services for others or work exclusively for you? The keys are to look at the entire relationship, consider the degree or extent of the right to direct and control, and finally, to document each of the factors used in coming up with the determination.

If, after reviewing the three categories of evidence, it is still unclear whether a worker is an employee or an independent contractor. Form SS-8, Determination of Worker Status for Purposes of Federal Employment Taxes and Income Tax Withholding can be filed with the IRS. The form may be filed by either the business or the worker. The IRS will review the facts and circumstances and officially determine the worker’s status.

If you classify an employee as an independent contractor and have no reasonable basis for doing so, you may be held liable for employment taxes for that worker. See Internal Revenue Code section 3509 for more information.

Workers who believe they have been improperly classified as independent contractors by an employer can use Form 8919 - Uncollected Social Security and Medicare Tax on Wages to figure and report the employee’s share of uncollected Social Security and Medicare taxes due on their compensation. 

In closing, when in doubt engage the services of a qualified CPA or tax attorney, familiar with these situations.

Gray Poehler is a volunteer with the Naples Chapter of SCORE.

A SCORE counselor since 2005, Gray Poehler owned and operated an independent insurance agency with 20 employees and two locations. He has earned the Certified Insurance Counselor designation and is familiar with both personal and commercial property and casualty insurance. Areas of expertise include: Business Finance and Accounting; Business Strategy and Planning; Business Operations; Human Resources and Internal Communications; Sales, Marketing and Public Relations.

To learn more about management issues of small businesses, contact the SCORE office nearest you.

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