When you hire a worker, one of the most important decisions you will make is classifying the worker as either an employee or an independent contractor. If you correctly classify a worker as an independent contractor, you are not required to pay the employer’s share of Social Security and Medicare taxes or to withhold income taxes from their pay.

Rule No. 1

The IRS uses the “right of control” test to make this classification. Under this rule, the IRS considers your worker an independent contractor if your business has the right to control only the result of the work—not how the worker does the work.

In most cases, if a worker qualifies as an independent contractor under this test, that’s the end of the matter. But there’s an exception: statutory employees.

You must classify some workers who meet the independent contractor definition as employees for payroll tax purposes. These workers are known as statutory employees, and they fall into just a few categories:

If your worker qualifies as a statutory employee, you must:

(Note: You do not have to withhold federal income tax.)

Rule No. 2

Naturally, businesses often prefer to classify such workers as independent contractors to avoid these obligations. Fortunately, not all workers in the categories listed above are automatically statutory employees. A worker is considered a statutory employee only if all three of the following apply:

If any one of the conditions does not apply, you don’t have to treat the worker as a statutory employee. Carefully structuring the relationship can help avoid an unintended employee classification.

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