As informational tax forms start flowing in, you are reminded to review the forms and determine the correctness of the form. One of the keys is whether your employer (or contractor) sends you the correct form. Getting it wrong could cost you plenty in the way of Social Security, Medicare taxes, and other employment-related taxes. Here is what you need to know.

The basics

As a contractor. If you are the worker and you are not considered an employee you must:

• Pay self-employment taxes (Social Security and Medicare-related taxes)
• Make estimated federal and state tax payments
• Handle your own benefits, insurance, and bookkeeping

As an employer. You must ensure your employee versus independent contractor determination is correct. Getting this wrong in the eyes of the IRS can lead to:

• Payment and penalties related to Social Security and Medicare taxes
• Payment of possible overtime including penalties for a contractor reclassified as an employee
• Legal obligation to pay for benefits

Determining the answer: Things to consider

Usually in determining whether you are an independent contractor or an employee, state and federal authorities look at the business relationship between the employer and you, the worker. The IRS focuses on the degree of control exercised by the business over the work done, and they will assess your level of independence. Here are some tips.

• The more the employer has the right to control your work, when the work is done, how the work is done, and where the work is done, the more likely you are an employee.
• The more the financial relationship is controlled by the employer, the more likely the relationship will be seen as an employee and not an independent contractor. To clarify this, an independent contractor should have a contract, have multiple customers, invoice the company for work done, and handle financial matters in a business-like manner.
• The more business-like the arrangement, the more likely you have an independent contractor relationship.

Don’t forget your obligations

With so many workers now in the contractor ranks, it is important to stay on top of your tax filing obligations. With 15.3% of your income due for Social Security and Medicare taxes, forgetting to pay this can quickly become a financial nightmare.

While there are no hard set rules, the more reasonable your basis for classification and the more consistently it is applied, the more likely an independent contractor classification will not be challenged by the IRS. But beware, states are trying to constantly move contractors into the ranks of employees, all of which can cause havoc as companies and workers try to understand the changes these initiatives create.