Contractor Test
Employee or Independent Contractor? – The Three Prong IRS Test
The age of hiring employees to handle all the needs of a business are long gone. We now live in the age of consulting and outsourcing. In many situations, it can be difficult to determine where the employee relationship ends and the independent contractor one begins. The IRS uses a three prong test.
The employee-independent contractor determination is an important one. From a legal perspective, businesses usually want people categorized as employees because anything those workers create is then considered property of the business. From a tax perspective, the opposite is true. Most businesses want to avoid paying payroll tax, worker’s compensation and so on for people who are not true employees of the business.
The IRS uses a three prong test to make the determination. The three prongs are Financial Control, Behavioral Control, and the Type of Relationship. Let’s take a closer look at each.
Financial Control – This refers to whether the business has the right to control the financial or business aspects of the worker’s job. For instance, the business might require the worker to charge a set price for something he or she produces and sells to affiliates of the business.
Behavior Control – This prong refers to the control the business has over how the work is done. If you hire a web designer to do a site and tell them what you want the final result to look like, you are not exerting control. If you tell them what program to use, how to do the design, provide training for them and so on, then you are exhibiting behavioral control.
Type of Relationship – This simply refers to the understanding between the parties. Put another way, what type of relationship do they believe they have?
The simple truth is there are a lot of individuals who are working as independent contractors, but are really employees for tax purposes. If you hire independent contractors, you should apply the three prong test the IRS uses to see how they should really be classified.
About the Author
Thomas Ajava writes for TaxIRSAttorneyOrlando.com – find an IRS tax attorney in Orlando.
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