Is your “independent contractor” truly one or is he or she, in reality, an employee? The distinction makes all the difference in the world on how you are treated by the IRS and the state of Colorado.

If he or she is truly an independent contractor, you have no obligation to pay a set salary, withhold his or her taxes, pay your share of his or her social security, pay for his or her workers’ compensation and other state required payments. On the other hand, if he or she is an employee, you are responsible for all of those items.

The IRS distinguishes if he or she is an independent contractor or an employee. Basically, an independent contractor is an independent business person who runs his or her business but does work for another business. An employee is hired by a company to perform specific work at the direction of the employer.

To help distinguish between employees and independent contractors, the IRS has set up three general criteria:

• Behavioral Control. If the employer trains and directs work, including hours of work, what tools or equipment are to be used, specific tasks to be performed and how the work is to be done, the worker is likely an employee. If the worker can set his or her own hours and works with little or no direction or training, he or she is probably an independent contractor.

• Financial Control. This factor includes how the worker is paid, if the worker may work for others at the same time and whether the worker can incur a profit or loss. A worker who is paid a salary, is restricted from working for others and does not participate in company profits or losses is probably an employee.

• Type of Relationship. Even though a contract might specify an “independent contractor”, this factor is not controlling. If the worker is entitled to benefits, this would indicate an employment relationship. Another factor would be the type of work the person does; if it is directly related to the company’s co-work, he or she is probably an employee.

When in doubt, the IRS assumes the worker is an employee. It is sometimes difficult to determine the status of a worker, so if you are unsure as to how to classify him or her, you can file an IRS form SS-8 to request the determination from the IRS.

Remember, an independent contractor is not an employee if he or she does not receive a paycheck and no social security and medicare taxes (self employment taxes) are withheld from his or her payments. Therefore, the independent contractor must pay self employment taxes at the end of the year along with his or her personal tax return.

Colorado goes by different guidelines, which are important for determination of workers’ compensation benefits. If a person is an independent contractor, it must be shown that the person for whom services are performed does not:

• require the individual to work exclusively for the person for whom the services are performed;
• establish a standard for the individual;
• pay the individual a salary or an hourly rate instead of a fixed or contract rate;
• terminate the work of the service provider during the contract period unless the service provider violates terms of the contract;
• provide more than minimal training for the individual;
• provide tools or benefits to the individual, except that materials and equipment may be supplied;
• dictate the time of performance, except that a completion schedule may be established;
• pay the service provider personally instead of making checks payable to a trade or business name of the provider; and
• combine the business operations of a person for whom service is provided in any way with the business operations of the service provider instead of maintaining all such operations separately and distinctly

While these guidelines are specified by statute, the courts often interpret them loosely.

Making the determination can be tricky, because even the courts sometimes look at the guidelines in different ways. It is important for the business owner to at least understand that there is a distinction between an independent contractor and an employee and merely designating someone as an independent contractor to simplify payment to him or her may not work with either the IRS or the state of Colorado. A good rule of thumb is to consult an experienced business attorney.