What are Independent Contractor Laws?

Independent contractor laws are tax and employment 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 an individual person or a business entity. Every jurisdiction will have different laws concerning independent contractors, but many of the basic principals remain the same.

In the U.S., classification as an independent contractor under the tax code by the Internal Revenue Service (IRS) exempts the contractor from paying employment taxes on money earned. Employers are required by law to deduct federal and state income taxes and to withhold Social Security and Medicare assessments from an employee’s paycheck. These amounts must be sent directly to the IRS. This ensures that the government receives its 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 control of the employer. A contractor is typically hired pursuant to a contract and has complete control over when, where, and how he completes the assigned work.

Whether the contractor is hired in his own capacity or through a business entity that the contractor has established, the independent nature of the relationship obviates the employer’s responsibility to withhold employment taxes. Amounts paid to the contractor are considered business income to him. The contractor is responsible for paying his own taxes, based upon how his business is organized.

In addition to classification laws based on the tax code, independent contractor laws also include employment laws that affect the contractor’s relationship to the employer and the employer’s responsibilities regarding 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 the actions of a contractor that fall outside of the scope of the contract. A contractor is not entitled to overtime pay or any of the benefits enjoyed by regular company employees.

The IRS has determined that the independent contractor laws are often used by workers to avoid paying taxes and by employers to avoid paying for employee benefits that are required by law. To combat this trend it has established an independent contractor test through rulings and additions to the tax code that enable 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.