How Does the IRS Define an Employee?

Most dictionaries define an employee as an individual who works for another person, or for a business, and receives payment.

Oh if it was only that simple.

The IRS further defines the relationship between an employer, or payer, and an employee, or payee. Before employers know how to treat payments made to individuals performing a service, there needs to be an understanding of the business relationship between the payer and the payee.

The person working for the employer, or under the employer, will fall into one of the following four categories. Below is a summation of each one.

Common-law employee

This is essentially the common employee. If I, as the employer, have the right to control not only the amount of work to be done, but also how it is to be performed, then the person I have hired is considered my employee.

It matters not the hours the person works, or if they are full or part time. It also does not matter what title I have given them. Calling an individual a worker, associate, contractor, partner, etc. does not mean they are not considered an employee for tax purposes.

For common-law employees, taxes withheld include federal and state taxes, and the employer’s portion of Social Security and Medicare taxes.

For more information of what defines an employee under common-law rules, see IRS Publication 15-A.

Independent contractor

An individual who offers their service directly to the public is generally considered an independent contractor. A person involved in a building trade, for example a roofer or hardwood floor installer, is an independent contractor. Individuals who have their own independent trade or business, like a doctor, is also considered an independent contractor.

If I, as the payee, am making payment to an independent contractor, I do not have to withhold taxes. It is their responsibility to do so. I would provide the person with a 1099-MISC by January 31 of the following year, not a Form W-2.

At times, it can be confusing as to if the person brought on to do work for the employer is an employee or an independent contractor. The general rule is that if you cannot direct the means and methods at which the person accomplishes the job for you, they are an independent contractor. See the article linked below for more information.

Statutory employee

The third category is a person who is an independent contractor by definition, but because of special circumstances, they are considered an employee by “statute.”

Statutory employees are limited to very specific professions. Delivery persons, full-time life insurance sales agents, a home-worker who is working on goods and products supplied to them, and full-time traveling sales people who work on the employer’s behalf and turn in orders to them, are statutory employees. Taxes must be withheld for most statutory employees.

Statutory non-employee

Even more obscure is the statutory non-employee. IRS Publication 15-A, referenced above, defines a statutory non-employee as direct sellers, licensed real estate agents, and certain companion sitters. The publication goes over additional rules that categorize these individuals.

By far, the individuals hired by most employers will either be common-law employees or independent contractors.

More from this Contributor:

Does the IRS consider you an employee or an independent contractor?

Your guide to small business tax deductions

What are my responsibilities as an employer?


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