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Business Assistance:
Home-Based & Micro Businesses in Mississippi - FAQ 14

Would it be better to hire independent contractors rather than employees?

Employee Categories

According to the IRS there are basically four types of business relationships between an employer and the person performing the services for the business. The appropriate category must be determined in order to insure that you, as an employer, are paying the correct employment taxes. The person performing the services may be:

• an independent contractor
• a common-law employee
• a statutory employee
• a statutory nonemployee

Independent Contractors People such as lawyers, contractors, subcontractors, public stenographers, and auctioneers who follow an independent trade, business, or profession in which they offer their services to the public, are generally not employees. However, whether such people are employees or independent contractors depends on the facts in each case. The general rule is that an individual is an independent contractor if you, the payer, have the right to control or direct only the result of the work and not the means and methods of accomplishing the result. [Note: If you classify an employee as an independent contractor and you have no reasonable basis for doing so, you may be held liable for employment taxes for that worker. For more detailed information regarding independent contractors vs. employee status, refer to the Employee or Independent Contractor? issue of Business Briefs.]

Common-Law Employees Under common-law rules, anyone who performs services for you is your employee if you can control what will be done and how it will be done. This is so even when you give the employee freedom of action. The key is that you have the right to control the details of how the services are performed. [Note: For more detailed information regarding independent contractors vs. employee status, refer to the Employee or Independent Contractor? issue of Business Briefs.]

If you have an employer-employee relationship it makes no difference how it is labeled. The substance of the relationship, not the label governs the worker's status. Nor does it matter whether the individual is employed full time or part time.

For employment tax purposes, no distinction is made between classes of employees. Superintendents, managers, and other supervisory personnel are all employees. You generally have to withhold and pay income, social security, and Medicare taxes on wages you pay to common-law employees.

Leased employees. Under certain circumstances, a corporation furnishing workers to various professional people and firms is the employer of those workers for employment tax purposes. For example, a professional service corporation may provide the services of secretaries, nurses, and other similarly trained workers to its subscribers.

The service corporation enters into contracts with the subscribers under which the subscribers specify the services to be provided and the fee to be paid to the service corporation for each individual furnished. The service corporation has the right to control and direct the worker's services for the subscriber, including the right to discharge or reassign the worker. The service corporation hires the workers, controls the payment of their wages, provides them with unemployment insurance and other benefits, and is the employer for employment tax purposes

Statutory Employees Four categories of workers who are independent contractors under the common law are treated by statute as employees. They are called statutory employees:

1. A driver who distributes beverages (other than milk) or meat, vegetable, fruit, or bakery products; or who picks up and delivers laundry or dry cleaning, if the driver is your agent or is paid on commission.

2. A full-time life insurance sales agent whose principal business activity is selling life insurance or annuity contracts, or both, primarily for one life insurance company.

3. An individual who works at home on materials or goods that you supply and that must be returned to you or to a person you name, if you also furnish specifications for the work to be done.

4. A full-time traveling or city salesperson who works on your behalf and turns in orders to you from wholesalers, retailers, contractors, or operators of hotels, restaurants, or other similar establishments. The goods sold must be merchandise for resale or supplies for use in the buyer's business operation. The work performed for you must be the salesperson's principal business activity.

Social security and Medicare taxes. Withhold social security and Medicare taxes from statutory employees' wages if all three of the following conditions apply.

• The service contract states or implies that substantially all the services are to be performed personally by them.

• They do not have a substantial investment in the equipment and property used to perform the services (other than an investment in transportation facilities).

• The services are performed on a continuing basis for the same payer.

Income tax. Do not withhold income tax from the wages of statutory employees.

Statutory Nonemployees

There are two categories of statutory nonemployees:
direct sellers and licensed real estate agents. They are treated as self-employed for all Federal tax purposes, including income and employment taxes, if:

1. Substantially all payments for their services as direct sellers or real estate agents are directly related to sales or other output, rather than to the number of hours worked, and

2. Their services are performed under a written contract providing that they will not be treated as employees for Federal tax purposes.

Direct sellers. Direct sellers include persons falling within any of the following three groups:

1. Persons engaged in selling (or soliciting the sale of) consumer products in the home or place of business other than in a permanent retail establishment.

2. Persons engaged in selling (or soliciting the sale of) consumer products to any buyer on a buy-sell basis, a deposit-commission basis, or any similar basis prescribed by regulations, for resale in the home or at a place of business other than in a permanent retail establishment.

3. Persons engaged in the trade or business of the delivery of distribution of newspapers or shopping news (including any services directly related to such delivery redistribution).

Licensed real estate agents. This category includes individuals engaged in appraisal activities for real estate sales if they earn income based on sales or other output.

Source of Information: IRS Publication 15A - Employer's Supplemental Tax Guide. Additional employer information can be found in IRS Publication 15 - Circular E, Employer's Tax Guide. Refer to these publications for complete information.