You pay another person to do work for you. Do you give them a 1099? Or do you give them a W-2 and withhold income taxes, pay Social Security taxes, and unemployment?

There are three groups of factors used to determine whether a person is an employee or an independent contractor:

1. Behavioral control. Do you direct or control how the worker does the work? If you have this control, the worker is an employee.
   
   If the worker receives less extensive instructions about what should be done, but not how it should be done, the worker may be an independent contractor. If the business provides training about required procedures and methods, this is a factor indicating that the worker is an employee.



2. Financial control. If the worker has a significant investment in his or her work, such as owning his or her own tools and equipment, this tends to indicate that the worker is an independent contractor. If the worker is reimbursed for business expenses, this also tends to indicate an independent contractor relationship. If the worker can realize a profit or loss, that is, the worker makes a profit only if his or her revenue exceeds expenses, this tends to indicate an independent contractor.
   
   On the other hand, if the worker simply receives payments, this tends to indicate an employee relationship.



3. Relationship of the parties. If the worker receives insurance, pension or paid leave, this is an indication that he is an employee.
   
   If the worker receives no benefits, however, he could be either an employee or an independent contractor.
   
   A written contract may show what relationship is intended between the worker and the business. While the written contract may be a factor, it does not control if the weight of other factors is opposite of the expressed intention.

An employer must withhold income tax and the employee's portion of social security and Medicare taxes. The employer must also pay Social Security, Medicare, and unemployment (FUTA) taxes on an employee's wages. The employee receives a Form W-2, Wage and Tax Statement, showing the amount of taxes withheld from his or her pay.

The employer gives an independent contractor Form 1099-MISC, to report payments that exceed $600 per year. The worker pays her own income tax and self-employment tax. The business does not withhold taxes or pay Social Security tax.

If workers are independent contractors under the above analysis, they may nevertheless be treated as employees by statute. Examples are a driver who distributes beverages (other than milk) or meat, vegetable, fruit or bakery products, a full-time life insurance sales agent whose principal business activity is selling life insurance or annuity contracts primarily for one life insurance company or an individual who works at home on materials or goods that you supply and that must be returned to you if you also furnish specifications for the work to be done.

There are two categories of statutory nonemployees: direct sellers and licensed real estate agents. They are treated as self-employed for all Federal tax purposes, including income and employment taxes, if substantially all payments for their services as direct sellers or real estate agents are directly related to sales rather than to the number of hours worked and their services are performed under a written contract providing that they will not be treated as employees for Federal tax purposes.

E-mail Patti Spencer at Patti@spencerlawfirm.com.