Independent Contractors: What’s the Difference Between an Independent Contractor and an Employee?

Many small business owners would like to know when they can hire an “Independent Contractor” vs. an “Employee.” This article is a modest effort to help clear things up a bit.

What IS an “Independent Contractor”?

First and foremost, and Independent Contractor is a business just like any other in Washington. That means the contractor must have, at minimum: (a) a Uniform Business Identifier (UBI) number, (b) a WA state business license (c) possibly also a business license in the city or town where it conducts business, and; (d) a special license for the type of work being done if a license is required for that trade.

The UBI number establishes an account at the state Department of Revenue – as a business, the Contractor pays Business and Occupation (B & O) taxes.

Let’s say Jane Doe considers herself an independent contractor. She’s an electrician, and a sole proprietor. She advertises her business, makes bids on jobs, is her own boss and sets her own schedule. She owns her own tools. She is a duly trained and licensed electrician. She has a UBI number and a state business license. Jane works in Seattle, so she also needs a Seattle Business license. Since her business is in King County, she should also be registered with a Personal Property account with the King County Assessor’s Office and may (or may not) owe personal property tax on business equipment. Jane’s business is subject to state B & O taxes on gross income. For federal income tax purposes, she may owe Self Employment (SE) tax (similar to tax withheld from a paycheck).

Now let’s look at John Doe. John also considers himself an independent contractor. He’s not an electrician, he is a yoga instructor in Seattle. His friend Mary runs a yoga studio, and John teaches classes there 3 days per week. Mary sets his schedule, and decides which classes he should teach. He does not advertise his services; instead, he relies instead on Mary’s marketing of the studio. He does not have a business license or a UBI number. Mary pays him cash. Both John and Mary are happy with this arrangement.

Is John really an independent contractor? No. Does it really matter, since he’s happy being called an independent contractor? Yes, it matters. If the Department of Labor & Industries (or the IRS) determines that John is not actually an independent contractor, that means he is Mary’s employee, and Mary (or her company), will be liable for paying John’s employment taxes that should have been withheld, will be liable for paying into the state worker’s compensation fund for employee John, and may owe other taxes and fees. Note: for Labor & Industries, a worker is presumed to be an employee unless it can be proven otherwise. This puts the burden on the business owner to show that the worker is listed and paid correctly.

Moral of the story: just calling yourself (or your worker) an “Independent Contractor” does not make it so.

Why is Jane and “independent contractor” and John is not? Because Jane meets the criteria that are used to define an independent contractor. If you are looking to hire an independent contractor, you must look for these criteria. The worker is an independent contractor only if she meets all 6* of them: (1) the worker is free from your “direction and control” (that is, you do not control the means and methods for how to get the job done); and (2) (a) the person performs a service that is outside the course of your business, or (b) the service is performed away from your location or job site, or (c) the contractor is responsible, in contract and in fact, for the costs of her own principal place of business; and (3)(a) she is engaged in her own business of providing the services you are looking to hire for, or (b) she has a principal place of business that qualifies for an IRS business deductio; and (4) she complies with IRS rules for filing a business tax return with the IRS, and (5) she has an active UBI number with the Washington Department of Revenue, and (6) she maintains her own set of books and records showing business income and expenses.

*In addition, those in certain construction trades must also (7) have a valid contractor registration per RCW 18.27 or 19.28. Jane also meets this test.

Washington’s Department of Labor and Industries wants people to understand the rules and the criteria for independent contractors, and has published a handbook to help explain things. It can be found at: http://www.lni.wa.gov/FormPub/Detail.asp?DocID=2134

The Handbook discusses the basic criteria listed above. The Labor & Industry criteria are similar to the ones used by the federal Department of Labor. It is important to understand these criteria, because they are what the relevant agencies will look at. Knowing what the agencies use to define “independent contractor” will help minimize problems for your small business. The last thing any business owner wants is the surprise of extra costs; so get educated about the difference between “independent contractors” vs. “employees”, and plan accordingly.

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