Subcontractor vs. Employee

by | Jun 15, 2021 | Taxes

This is the area that is probably near and dear to a lot of small business owners-do I classify those who work for me as a subcontractor or an employee? Having subs is easier from an employer perspective-you issue a 1099 at the end of the year if you paid them over $600 (make sure to get their vendor info!) and you don’t need to worry about paying payroll taxes or filing quarterly payroll reports, etc. However, from an employee standpoint-it is not nearly as convenient to be a sub-after all, that means you are self-employed, which means you will be paying higher taxes at the end of the year and there will be no benefits, like unemployment or worker’s comp, etc.

The general rule of thumb according to the IRS, if you are able to direct the result of the work, but not WHAT or HOW it gets done, the worker is a subcontractor.

3 main criteria are:

  1. Behavioral control: type and degree of instruction given, types of evaluation used, and training given
  2. Financial control: equipment invested by the employee to perform the job, method of payment (flat rate vs. regular wage), unreimbursed expenses
  3. Relationship: are there contracts, benefits, permanency of the relationship, services provided as key activity for the business

Classifying an employee as a subcontractor with no reasonable basis will make you as a small business owner liable for employment taxes. Certain employers can avoid paying employment taxes if they provide reasonable basis for not treating their workers as employees. The rules to qualify for exceptions are detailed in this publication https://www.irs.gov/pub/irs-pdf/p1976.pdf

Voluntary Classification Settlement Program (VCSP) allows taxpayers the opportunity to reclassify their workers as employees for partial relief from paying employment taxes in future periods. There are certain eligibility requirements. More on this here: https://www.irs.gov/businesses/small-businesses-self-employed/voluntary-classification-settlement-program

Employers can figure out the proper classification using Form SS-8 https://www.irs.gov/forms-pubs/about-form-ss-8

And Publication 15-A https://www.irs.gov/forms-pubs/about-publication-15-a

Employees who think they have been improperly classified as subs can figure out the amount of uncollected Medicare and Social Security taxes owed to them using Form 8919 https://www.irs.gov/forms-pubs/about-form-8919