As an annual reminder, it makes sense to review the key determination on whether your work activity is deemed employment or as an independent contractor. Getting it wrong could cost you plenty in Social Security, Medicare and other employment-related taxes. Here’s what you need to know while there’s still time to plan for your upcoming tax bill.

The basics

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

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

As an employer. You need to correctly determine whether a worker is an employee or an independent contractor. Misclassifying an employee as an independent contractor can lead to:

• Interest 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 employee benefits

Determining the answer: Things to consider

Determining whether you’re an independent contractor or an employee usually comes down to the working relationship between you and the business paying you. The IRS looks at how much control the business has over what you do and how you do it, along with your level of financial independence and the overall relationship between the two parties. Here are some things to consider.

• The more control the employer has over what work you do, when and where you do it, and how you get it done, the more likely you are to be considered an employee.
• The more control the business has over the financial side of your work, the more likely you are to be considered an employee.
• The more the working arrangement resembles a relationship between two separate businesses, the more likely you are to be considered an independent contractor. For example, you may have a contract, work for multiple customers, invoice for your services and handle expenses and other financial matters yourself.

Don’t forget your tax obligations

With so many people working as independent contractors, it’s important to stay on top of your tax obligations. Self-employment tax is generally 15.3% of net earnings from self-employment (12.4% social security tax plus 2.9% Medicare tax), so forgetting to account for it throughout the year can leave you with a much larger tax bill than expected.

Worker classification isn’t determined by any single factor. Instead, the IRS looks at the entire working relationship and the degree of control and independence involved. State rules may also differ from federal requirements, which means a worker could be treated differently depending on which rules apply. As these requirements change, both businesses and workers need to keep up with how their working arrangements may be affected.