Independent contractor laws determine when a worker can be classified as a contractor and how they should pay taxes. Contractors are not employees and are responsible for their own taxes. Employers are not liable for providing benefits or insurance to contractors. The IRS has a test to prevent misuse of independent contractor classification.
Independent contractor laws are labor and tax laws that specify when a worker can be classified as a contractor rather than an employee, and also specify how this type of worker should pay income taxes. A contractor can be a natural person or a commercial entity. Each jurisdiction will have different laws regarding independent contractors, but many of the basic principles remain the same.
In the United States, classification as an independent contractor under the Internal Revenue Service (IRS) tax code exempts the contractor from paying employment taxes on money earned. Employers are required by law to deduct state and federal income taxes and to withhold Social Security and Medicare assessments from an employee’s paycheck. These amounts must be submitted directly to the IRS. This ensures that the government receives the tax money before the employee has a chance to spend it.
Contractors are not employees under independent contractor laws. The IRS has distinguished contractors by noting that they do not work under the employer’s control. A contractor is typically hired under a contract and has complete control over when, where and how he completes the assigned work.
Whether the contractor is engaged on its own or through a business entity that the contractor has set up, the independent nature of the relationship avoids the employer’s liability to withhold labor taxes. The amounts paid to the contractor are considered business income for him. The contractor is responsible for paying his own taxes, depending on how his business is organised.
In addition to tax code-based classification laws, independent contractor laws also include labor laws that affect the contractor’s relationship with the employer and the employer’s responsibilities to the contractor. For example, an employer is not responsible for providing health insurance or worker’s compensation insurance to a contractor. An employer is not responsible for a contractor’s actions that are outside the scope of the contract. A contractor is not entitled to overtime pay or any of the benefits enjoyed by regular employees of the firm.
The IRS has determined that independent contractor laws are often used by workers to avoid paying taxes and by employers to avoid paying employee benefits required by law. To counter this trend it has instituted an independent contractor test through rulings and tax code additions that allow the IRS to declassify an individual as a contractor. If an individual is stripped of his classification, he and the employer are both liable for back taxes and penalties.
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