Categorizing Employees vs. Independent Contractors

Small business owners in Minnesota often wonder whether a person who works for them should be considered an employee or independent contractor for tax purposes. Here are the factors to consider.

As a business owner, whether you hire someone as an independent contractor or as an employee will impact how much taxes you pay and the amount of taxes you withhold from their paychecks. Additionally, it will affect how much additional cost your business must bear, what documents and information the worker must provide to you, and what tax documents you must give to the worker.

Here are a few tips to help Minnesota small business owners when considering whether to hire people as independent contractors or hire them as employees. If you are not from Minnesota, you may still use these guides, because they are offered by the IRS and applicable throughout the United States.

The IRS uses three characteristics to determine the relationship between a company and its workers: (1) Behavioral Control, (2) Financial Control, and (3) the Type of Relationship.

  1. Behavioral Control. 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.
  2. Financial Control. 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.
  3. Type of Relationship. The Type of Relationship factor relates to how the workers and the business owner perceive their relationship.

If you have the right to control or direct not only what is to be done, but also how it is to be done, then your workers are probably employees. If you can direct or control only the result of the work done — and not the means and methods of accomplishing the result — then your workers are probably independent contractors.

What Does Having the Right Classification Matter?

For Employers: Employers who misclassify workers as independent contractors can end up with substantial tax bills. Additionally, they can face penalties for failing to pay employment taxes and for failing to file required tax forms. For Workers: Workers can avoid higher tax bills and lost benefits if they know their proper status.

An Answer for Your Situation

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

More Small Business Tax Information

You can learn more about the critical determination of a worker’s status as an Independent Contractor or Employee at the IRS website for small business tax issues. For example, check out 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).

Minnesota Test for Employee vs. Independent Contractor

The State of Minnesota has its own test for determining whether a worker is an employee or independent contractor. The state’s concern relates to employee rights laws including the employee’s right to workers compensation and the employee’s right to unemployment benefits. Learn more here: Minnesota employee and independent contractor law.

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