Are you hiring an employee or an independent contractor? Your answer to this question will have a big impact on your business taxes. Therefore, you must 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. For an employee, you must withhold income, Social Security and Medicare taxes. You will deposit and report the withholdings in accordance with the IRS guidelines in Publication 15, Employer’s Tax Guide.

For an independent contractor, on the other hand, you do not have to withhold taxes. However, you will still distribute a form to them come filing season — Form 1099-MISC (instead of the W-2 you would fill out for an employee).

What Determines Employee Status?

You’re probably wondering about the functional difference between an employee and a contractor. So, let’s start with employees. The IRS defines an employee relationship as one in which you, the employer, “can control what will be done and how it will be done.” Employees are generally given training, resources and benefits. They have a portion of their pay withheld for taxes.

What Determines Independent Contractor Status?

For the most part, independent professionals who offer their services to the public are considered independent contractors. This description includes doctors, accountants, lawyers, photographers, designers and writers alike. Unlike in an employee relationship, you as the payer relinquish a portion of control over the contractor’s time. You still dictate fulfillment of an agreed-upon task, but you are not in control of the contractor’s means to completion.

Independent contractors pay self-employment tax on their earnings, while employees typically receive a refund for taxes withheld.

What Is a Statutory Employee or Statutory Nonemployee?

These terms can be confusing, but there’s a good chance you won’t be dealing with them. Just so you understand the concepts, a contractor may be filed as a statutory employee if they fall within various IRS specifications. Social Security and Medicare taxes may be withheld if a statutory employee a) performs all service personally, b) does not have an investment in the work equipment and property, and c) performs the work on a continuing basis.

A statutory nonemployee is usually a direct seller or a real estate agent. They are self-employed for tax purposes if a) their wages are related to their output rather than the number of working hours, and b) they work under a written contract specifying that they are not employees.

Common Law

There are three common-law categories to weigh when determining whether your worker is an employee or contractor: behavior, financials and type of relationship. Do you have control over how the worker does their job? What are the financial agreements? Are you providing additional benefits? These types of questions help paint a bigger picture and eventually lead you to a final answer.

If You’re Not Sure

If you’re still having trouble deciphering employees from independent contractors, you can consult and file Form SS-8. The IRS can then offer an official determination.