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Are you hiring an employee or an independent contractor? Your answer to this question will make a big different on your business taxes. You need to know the different types of business relationships and what they mean for you as a small-business owner.

The Fast Answer

In terms of taxes, the difference between an employee and a contractor is simple. Let’s start with employees. You need to withhold income, Social Security and Medicare taxes. You’re responsible for depositing and reporting tax withholding in accordance with the IRS guidelines in Publication 15, Employer’s Tax Guide. And at the end of the year, you’ll issue them a Form W-2.

For an independent contractor, on the other hand, you don’t have to withhold taxes, because they’re responsible for paying their own self-employment taxes. At the end of the year, you’ll issue them a Form 1099-MISC to report what you paid them.

What Determines Employee Status?

There’s a functional difference between employees and independent contractors. The IRS defines an employment relationship as one in which the employer controls what will be done and how it will be done. Employees are generally given training, office supplies and equipment (such as computers) and benefits.

What Determines Independent Contractor Status?

On the other hand, independent contractors determine what they will do and how they will do it. Often they provide their own computer and set their own hours. It’s not an employment relationship, but rather a vendor relationship. You can dictate what the end result should look like, but you are not in full control of how it gets done.

Common Law

There are three common-law categories to weigh when determining whether your worker is an employee or contractor:

  • Behavioral: Does the company control or have the right to control what the worker does and how he/she does their job?
  • Financial: Who controls how the worker is paid, who provides tools and supplies, and are their expenses reimbursed?
  • Type of Relationship: Does the worker receive company benefits in the same way an employee would? Does the relationship have a specified end point? Is the type of work the individual performs a key aspect of your business?

Still Not Sure?

If you’re still having trouble separating out employees from independent contractors, you can read more on the IRS website by clicking here. And for a definitive answer, you can file Form SS-8 to set out the facts and circumstances for an IRS determination.