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Independent Contractor vs. Employee: What’s the Difference?

Written by Nickel - 25 Comments

I just ran across an interesting post about hiring a housekeeper over at GetRichSlowly. In the comments, a reader asked JD about how they handle the tax issues. His response was:

Our housekeeper is not our employee; she is an independent contractor. Because of this, taxes aren’t an issue.

This is a convenient answer, but is it true? It’s clearly beneficial from a tax perspective to hire your housekeeper as independent contractor vs. an employee, but just because you claim they are an independent contractor doesn’t necessarily make it true.

According to the IRS:

To determine whether a worker is an independent contractor or an employee under common law, you must examine the relationship between the worker and the business. All evidence of control and independence in this relationship should be considered. The facts that provide this evidence fall into three categories – Behavioral Control, Financial Control, and the Relationship of the Parties.

While I’m not a tax expert, it seems likely to me that JD’s going to run into trouble with the Behavioral Control aspect, where the IRS is interested in whether or not the employer “has a right to direct or control how the work is done, through instructions, training, or other means.” I’m guessing that JD and his wife do exert some level of control over the work being done.

As further evidence that the IRS frowns on treating a housekeeper as an independent contractor, check out IRS Tax Topic 756, where it states:

Household employees include housekeepers, maids, baby-sitters, gardeners, and others who work in or around your private residence as your employees. Repairmen, plumbers, contractors, and other business people who work for you as independent contractors, are not your employees. Household workers are your employees if you can control not only the work they do but how they do it.

Also note that the IRS has ruled in the past that the employee/contractor issue is dependent on the nature of the relationship, and not the existence of a contract stating that someone is an independent contractor. Again, just because you say someone is a contractor doesn’t mean that it’s true.

Now… As I noted above, I’m not a tax expert, so perhaps my interpretations are wrong. As always, please feel free to chime in by leaving a comment if you have anything to share.

Published on February 19th, 2010 - 25 Comments
Filed under: Self Employment, Taxes

About the author: is the founder and editor-in-chief of this site. He's a thirty-something family man who has been writing about personal finance since 2005, and guess what? He's on Twitter!

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25 Responses to “Independent Contractor vs. Employee: What’s the Difference?”

  1. 1
    Lakita (PFJourney) Says:

    Interesting…I thought the relationship was more based on the agreement between the client and service provider…the main difference being who is responsible for paying the taxes. I mean, they would get paid either way right?

    Either
    a. Employer withdrawals taxes and makes payment
    b. Service provider’s income recorded on 1099 and makes payment

    Thanks for bringing this up. I’d like to know the definitive answer on this as well.

  2. 2
    My Frugal Miser Says:

    Lakita – that’s not necessarily true. If I am paid on a 1099, I can deduct the expenses associated with generating the income. For example, I can use a home office to schedule my work and plan my day, and then “travel” to where I am going to perform the work, deducting the mileage both ways. An employee can’t do this.

    Since I can deduct these expenses from the income reported on my 1099, the amount that I actually pay taxes on will be something less than the total amount I as an employee would be taxed on.

  3. 3
    missjulied Says:

    Maybe she’d be their employee if she worked for them full-time, or for them alone, but she clearly has her own business working for a bunch of different clients. Is she supposed to be an “employee” of ALL of them? That just doesn’t make sense.

  4. 4
    Lynn Says:

    The gov’t considers house keepers to be household employees. However, if you paid less than $1700 to a household employee in 2009 (& 2010) you don’t have to pay employment taxes. Over $1700 then you have to pay FICA. If you paid over $1000 in any calendar quarter in 2009 or 2010 then you also have to pay unemployment. Just keep these numbers into account when hiring someone.

  5. 5
    Bryan Says:

    I’ve gotten the impression from that section of the tax law that the real answer is, it depends. For example a full time housekeeper is definitely your employee. However, as with JD’s case where they come in once a week to clean they are an employee of the housekeeping service they work for, even if it is their own business and would therefore be an independent contractor to you.

    Also as far as controlling the work they do and how they do it. I’m sure they tell her what to clean but I would assume its largely up to the housekeeper if she wants to clean the kitchen first then the bathroom then the rest of the house, or some other order. To me control over how they do the work would be like saying ok you are going to use 409 on the bathroom with paper towels then soft scrub and a sponge in the tub, when you get to the kitchen use mr clean and make sure the final wipe is in vertical lines. Obviously this seems a bit extreme for a housekeeper, but is more vague than instructions you would find in a production factory. Basically I think the housekeeper wouldn’t be an employee because they have more autonomy over how the job gets done.

  6. 6
    Lynn Says:

    The IRS publication is pretty clear. They use lawn service as an example. My interpretation as it refers to a housecleaner: If you have a person that cleans your whole house how they want, uses his/her own cleaners, rags, vacuum, etc then it wouldn’t be your employee. If you provide any of the cleaners and equipment and/or specify you only want the upstairs/downstairs or specific rooms cleaned and exactly how you want them done then they are your employee. The question is how to prove it if there is ever an audit of any kind.

  7. 7
    J.D. Says:

    Now I have something else to ask my accountant about when we take in our taxes! :)

  8. 8
    Jenny Says:

    I think it depends on the nature of the Housekeeper’s business. If Merry Maids comes into your home and cleans it, they’re an independent contractor just as if a plumber who works for a plumbing company comes into your home is an independent contractor. If the housekeeper has a company for cleaning houses, it would seem to me that she’d be an independent contractor – if she has a business license and files taxes etc as a business. I don’t think the homeowner would be liable for taxes since it’s a business.

  9. 9
    Dan Says:

    I like the circular logic that the IRS uses:

    “Household employees include… [anybody] who work[s] in or around your private residence as your employees.”

    IC’s are:

    “… other business people who work for you as independent contractors are not your employees.”

    Now, I can’t think of *any* example wrt Independent Contractors where the paying party provides *no* direction whatsoever to the IC. Simply telling somebody to clean my apartment or mow my grass doesn’t constitute instruction IMHO.

  10. 10
    Lynn Says:

    Jenny – good point. My responses were based solely on an individual coming into your house and cleaning and you paying cash etc…

  11. 11
    Dan Says:

    missjulied,

    I can imagine a situation where a person has four or five legitimate part-time jobs for separate employers. (Say four gigs each at 20 hours.) In this case the person truly is an employee of each of them.

  12. 12
    Nickel Says:

    Jenny: Merry Maids is a different thing entirely. In that case, you are paying a company a service fee and they have *their* W-2 employees come to your house and clean it. They are *not* an independent contractor, and you do not need to issue them a 1099.

    The argument that an “independent” housekeeper qualifies as a business owner who employs him/herself is an interesting one, but I suspect that it would only hold water if they had actually incorporated and were doing a formal payroll (and issuing themselves a W-2).

    I bet many independent housekeepers don’t do this because they’d prefer to keep their income “off the books.”

  13. 13
    almost there Says:

    Lynn is correct on the over $1700 rule. Incidently, my spouse worked as a paramed doing insurance physicals. The company shafted her by treating her as an IC and not an employee. I called the IRS on this and they said that if the employer tells the person where to be to perform the work that they were an employee. Clearly the appointment schedule dictated by the employer told her to go to take the physicals. But if she wanted to work it was to be as an IC according to her employer. We figured out that she was making less than minimum wage based on the amount of time she was putting in driving all over and the pre and post physical paperwork, faxing, and phone calls. She didn’t have that job many years.
    As far as housekeepers go, don’t politicians always get in trouble because they hire houskeepers and do not pay them as an employee (as a tax dodge) and then the press gets wind of it?

  14. 14
    therealdebtsolution Says:

    I have a unique perspective when it comes to independent contractors. I have owned and operated a weekly advertising magazine for 20 years and I’ve always filed my sales teams as independent contractors. And I have a housekeeper that’s an independent contractor.

    Basically this is what I’ve learned from real experience. The IRS has what’s in writing and what’s in practice. This is way everyone is confused about tax laws. We can see that from the guy that just flew the plan into the IRS bld. in Austin Texas.

    It really comes down to this…the IRS considers an independent contractor someone that doesn’t solely work for you. That’s why travel agencies are the most audited firms. The travel agent usually works in an office provided by their contractor and they can’t book for another travel firm they must book through the firm they are working at.

    So are they really independent? Yes and No! So this is what usually happens. When the firm turns in their 1099 statements claiming the money paid to their independent contractors to the IRS the IRS will then check to see if the independent contractors paid the tax on that money. If they didn’t they will contact the contractor if they don’t pay the IRS usually goes after the contractor.

    NOTE: this is only when an audit is performed. Millions of companies get away with this every year!

    In summary…if you only allow your housekeeper, salesreps, handyman crew to only work for you they are technically not an independent contractor.

  15. 15
    Bender Says:

    Like Bryan said. There are no hard and fast (black and white) rules here. The IRS three prong test is really just an analytical framework for evaluating various factors indicative of the type of relationship.

    As others have pointed out, virtually all indepedent contractors are subject to some type of behavior control. So the mere fact that you tell your maid that you only want the upstairs cleaned isn’t going to make him/her your employee.

    If you want to be bullet proof file a Form SS-8 and see what the IRS says.

  16. 16
    Kevin M Says:

    This is a tricky situation (employee vs. independent contractor) and the IRS really likes to scrutinize it – although for these small dollar amounts maybe not. It really does take analysis of all the facts and circumstances on a case by case basis. I’m surprised the author didn’t look into IRS Publication 926, since it’s directly on point.

    http://www.irs.gov/publications/p926/index.html

    Specifically this seems to apply to JD:
    Workers who are not your employees. If only the worker can control how the work is done, the worker is not your employee but is self-employed. A self-employed worker usually provides his or her own tools and offers services to the general public in an independent business.

    In my professional experience, JD is probably ok, unless his housekeeper comes along later and claims she was an employee and taxes should have been withheld.

  17. 17
    mightymouselives Says:

    The $1700 figure is really bizarre. A once a month housekeeper might easily charge $150 a day, that’s 1800 right there. I can’t imagine treating a once a month person as an employee. Why would this be?

  18. 18
    Snowballer Says:

    It’s an issue of substance v. form.

    Thought exercise: everyone that hires this housekeeper is supposed to issue her a W2? So if she has 20 clients, she gets 20 W2s? Are you serious?

    You really expect 20 people who probably don’t know how to issue a W2?

    I can’t imagine the housekeeper does anything other than put her income on a Schedule C and deduct the costs of her supplies, depreciation, vehicle expenses, etc. and wind up paying the SE taxes on it. The housekeeper might use an S corporation perhaps but the same basic thing would apply as she’d have to pay herself as officer of the corporation.

    Now if this were a situation where she were somebody’s household servant, yes she’d be an employee and declare the income as wages.

  19. 19
    Mrs. Accountability Says:

    Regarding Snowballer’s comment: W2s are issued by employers who are required by law to collect and report quarterly withholding taxes. So it would more likely be a 1099-MISC issued by all 20 clients. This was a question for our accountant recently because my husband pays our son to work with him in his business. If my husband had our son working with him on a regular basis, we would be required to file Form 941 every quarter, collecting and paying SS, Medicare and Federal withholding taxes. But since he works with him sporadically, we only have to issue the 1099-MISC. The IRS expects the housekeeper to report all income, regardless of whether a 1099-MISC was issued or not…

  20. 20
    Doctor Stock Says:

    I suspect most government tax agencies error on the side of screwing the individual and making sure they don’t have such loopholes :)

  21. 21
    Ron Says:

    I’m not a “tax” expert, but I am a Human Resources expert. It all boils down to How, When, and Where. We hire IC’s all the time.

    How the work is done and how much of the IC’s income comes from you.

    When the work is done. It has to be reasonable of course, and there can be some stipulations (by Wednesday, no later than the 15th of next month, etc) but not so specific as to define an exact time. In the case of a housekeeper, it the door is locked between 8am and noon, she will undoubtedly understand she will show up after lunch.

    Where the work is done. In most IC cases, there is an understood degree of reasonableness here as well. The lawn service HAS to perform their work on YOUR lawn, right? In the case of the housekeeper, you CAN tell them to NOT clean the garage, the master bedroom or whatever room you wish. You can’t tell a web designer to show up at your office to do all the work or tell your IC sales staff that they have to come into the office to do a physical inventory.

    The best bet is to set up a contract, outlining what work is to be done, the amount to be paid, and who will be responsible for the taxes.

    Oh yeah, you might want to make sure they have their own insurance (worker’s comp and liability) and that they are bonded.

    PS – generally politicians get in trouble with housekeeper’s taxes because the housekeeper works ONLY for them.

  22. 22
    Snowballer Says:

    Mrs. Accountability: Thank you, that’s what I was driving at, trying to point out the absurdities of expecting all clients to act as employers and take care of FICA and withholding and such when it’s the housekeeper’s responsibility to report her own income.

    The fact of the matter is though, who the heck is going to issue their housekeeper a 1099 MISC? Very few people would even think to do that. A business client probably would but not some individual, who probably just writes her a check or pays cash and thinks nothing of it.

    Most small businesses are just on their own to honestly report their income and keep records proving their income is what they say it is.

    I’m sure lots of people cheat but then again lots of people don’t.

    Again, it’s substance vs. form. If the housekeeper does multiple clients, drives herself around, brings her own cleaning supplies she’s self employed. If she worked for one person consistently all the time, she’s an employee.

  23. 23
    geo Says:

    “The fact of the matter is though, who the heck is going to issue their housekeeper a 1099 MISC? Very few people would even think to do that.”

    Ignorance is not an excuse, and this is where people get into trouble. “It’s just a housekeeper” will not convince the auditor. If you are handing someone hundreds of dollars, then its your responsibility to understand the relevant tax law. The person you are paying, of course, is also responsible to know the tax law from their perspective, but you have no control over that.

  24. 24
    John @ TheChristianDollar.com Says:

    Great article on something that so many people try to get away with!

  25. 25
    geneva cloud Says:

    I worked full time for a family in which the wife offered me the housekeeping job monday through friday 8-4 and an hourly wage, she buying all the supplies and she directed the work via notes she left in the laundry room each day. She paid me with personal checks each monday. I asked her if she planned to issue a 1099 and she said ” no, she dont issue anything like that unless i go on her payroll and i told her if she didnt issue a 1099 then she may have to pay taxes on the previous 6 months and she said that she knew all that and asked if i wanted to go on her payroll with a dollar more an hour, holiday pay , and vacation pay and i said yes so i worked like that for 6 momths till she fired me then when i applied for unemployment in july she then mailed me a 1099. I have since found out that i should have been an employee all along. Now i must file an SS8 with the irs to get a determination whether i was an employee or contract labor.
    .

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