Who's an independent contractor, and who's an employee?
How an employer defines the relationship that exists when someone performs services can have a large impact on the way a business operates. A person performing services might be: an independent contractor, a statutory employee, a common-law employee or a statutory non-employee.

An employer generally must withhold income tax, withhold and pay social security tax, and pay unemployment taxes on wages paid to an employee. A business does not usually have to withhold or pay taxes on money paid to independent contractors.

Misclassification of the employer-employee relationship is a prime area for IRS enforcement. The IRS has targeted the "contract labor" category of payment as one that is easily and frequently abused. They are taking a serious look at anyone classified as "contract" to be sure the person has not been misclassified by a firm, which should more properly be called their employer.

If someone is truly an independent contractor, the business contracting for services must provide a 1099-MISC to the individual if they were paid more than $600.00 in the calendar year. This is the Statement to Recipients of Miscellaneous Income, and copies must be filed with appropriate state and federal agencies, similar to a W-2.

Self-employed individuals shoulder the burden of paying the appropriate federal, state and local income taxes. In many cases, they should be making estimated tax deposits on a quarterly basis.

Employers should also note that most states have separate sets of guidelines on what constitutes an employer/employee relationship. Frequently these differ dramatically from those of the federal government. Employers should review all sets of applicable criteria when deciding how to classify a worker.

More information can be found by visiting the IRS Web site at www.irs.gov. There, you can either request Publication 15 — Circular E, Employer's Tax Guide, or review Topic 762 in the "Small Business Section." If you believe that your situation is unclear after reviewing the materials, you may complete FORM SS-8, and the Internal Revenue Service will make the decision for you. This form can be downloaded from the IRS site, or ordered at 1-800-829-3676 (TAX-FORM).

Using independent contractors can be a good business decision, and can save employers money in payroll taxes, employee benefits, and workers' compensation costs. Nonetheless, it pays to be careful, since mistakes can be costly. An employer must have a reasonable basis for treating a worker as other than an employee. If there is not a good reason for doing so, you may be subject to large fines and back taxes.