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Small Business Digest


Hiring Independent Contractors Versus Employees: The Tax Impact

Small-business owners need to know that their decisions to hire independent contractors on one hand or regular employees on the other will have an impact on taxes.

Those decisions will affect how much tax the business will have to pay and withhold from paychecks.  Also affected will be what documents and information must be provided to the business, and what tax documents the business must give to the employee or contractor.

Here are the top 10 things every business owner should know about hiring workers as independent contractors versus hiring them as employees:

1. The Internal Revenue Service uses three characteristics to determine the relationship between businesses and workers: Behavioral Control, Financial Control, and Type of Relationship.

2. Behavioral Control covers facts that show whether the business has a right to direct or control how the work is done through instructions, training or other means.

3. Financial Control covers facts that show whether the business has a right to direct or control the financial and business aspects of the worker's job.

4. The Type of Relationship factor relates to how the workers and the business owner perceive their relationship.

5. If the company has the right to control or direct not only what is to be done, but also how it is to be done, then workers are most likely employees.

6. If the company can direct or control only the result of the work done - and not the means and methods of accomplishing the result - then workers are probably independent contractors.

7. Employers who misclassify workers as independent contractors can end up with substantial tax bills. Additionally, employers can face penalties for failing to pay employment taxes and for failing to file required tax forms.

8. Workers can avoid higher tax bills and lost benefits if they know their proper status.

9. Both employers and workers can ask the IRS to make a determination on whether a specific individual is an independent contractor or an employee by filing with the IRS a Form SS-8 – Determination of Worker Status for Purposes of Federal Employment Taxes and Income Tax Withholding.

10. You can learn more about the critical determination of a worker’s status as an independent contractor or employee at by selecting the Small Business link.  Additional resources include IRS Publication 15-A, Employer's Supplemental Tax Guide; Publication 1779, Independent Contractor or Employee; and Publication 1976, Do You Qualify for Relief Under Section 530? These publications and Form SS-8 are available on the IRS Web site or by calling the IRS at 800-829-3676 (800-TAX-FORM).

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