As your business grows, you may need to bring on someone to help you. This might mean working with a virtual assistant for things like social media management or customer support, hiring a photographer for your Etsy shop or blog, or finding someone to help you fulfill orders for your Etsy shop. But before you begin looking for assistance, you need to figure out whether you’re hiring an employee or an independent contractor. It’s important to realize that these two terms (like most things in business) are defined by the IRS. In this post I’ll review the main rules so you can see which category you need to use.
This post is for informational purposes only. IRS guidance on this topic can be found here.
Behavioral Considerations: Independent Contractor Versus Employee
There are three major factors the IRS considers when classifying employees versus independent contractors. The first category is behavioral. The question to ask for this aspect is: does the company control or have the right to control what the worker does and how the worker does his or her job?
An employee is generally subject to the business' instructions about when, where, and how to work. Here are some examples of work instructions:
- When and where to do the work.
- What tools or equipment to use.
- What workers to hire or to assist with the work.
- Where to purchase supplies and services.
- What work must be performed by a specified individual.
- What order or sequence to follow when performing the work.
For example, I do not tell my Pinterest VA when and where to do her work. I don’t set her hours. She is an independent contractor.
Another example. If you are an Etsy shop owner who hires people to help make your products, and you require that those workers work in your workshop and use your tools and equipment, then most likely those workers would be employees.
If you train your workers on how to do the job, this could be evidence that they are employees. Independent contractors usually use their own methods to accomplish a job.
The second aspect of the employee/independent contractor is financial. You need to determine whether the business aspects of the worker’s job are controlled by the payer. Things that fall into this category include things like how a worker is paid, whether expenses are reimbursed and who provides tools/supplies, etc. For example, most often an independent contractor invoices their client and provides their own job tools and supplies. In addition, expenses are not reimbursed by the client. An employee is often provided tools, reimbursed for job related expenses, and does not invoice their employer.
The opportunity to make a profit or loss is another key factor. If a worker has a significant investment in the tools and equipment used and if the worker has unreimbursed expenses, the worker has a greater opportunity to lose money (i.e., their expenses will exceed their income from the work). Having the possibility of incurring a loss indicates that the worker is an independent contractor and not an employee.
Furthermore, an independent contractor is generally free to seek out business opportunities. Independent contractors often advertise, maintain a visible business location, and are available to work in the relevant market.
Type of Relationship
The third major consideration to assess is the type of relationship. You need to consider questions like whether you are providing employee benefits. If you are providing benefits, this often indicates an employee relationship. Another important question is will the relationship continue indefinitely? Ongoing relationships tends to indicate an employee relationship. You also need to ask if the service provided is a key part of the business. If a worker provides services that are a key aspect of the business, it is more likely that the business will have the right to direct and control his or her activities. For example, if you hire someone to make your handmade product that you sell on Etsy, you are probably directing and controlling their activities, and this may indicate and employee relationship.
The keys are to look at the entire relationship, consider the degree or extent of the right to direct and control the worker.
The general rule is that an individual is an independent contractor if the payer has the right to control or direct only the result of the work and not what will be done and how it will be done.
When it comes to the employee versus contractor question, the key is to look at the entire relationship, and consider the degree or extent of the right to direct and control the worker. The general rule is that an individual is an independent contractor if the payer has the right to control or direct only the result of the work and not what will be done and how it will be done. If you need more information to help you determine if the person you have hired is an independent contractor or an employee, you can get more details from this IRS document.
One final aspect of the employee/contractor discussion is payment. The easiest way to pay an independent contractor is through a service provider such as PayPal or Venmo. (It will save you having to file a 1099 for the contractor at year end.)
If you determine you have an Employee, you are required to withhold payroll taxes from their pay and remit them to the state and IRS. You will also need to pay an employer’s share of the payroll tax. Payroll can be complicated, so the best thing to do is use a payroll company to pay your employees. I recommend Gusto. Gusto is a great low cost payroll option, and they do all the work for you! You don’t need to worry about filing payroll tax returns, or calculating the payroll taxes, they handle everything!