1. Who Are Employees? Before you can know how to treat payments you make for services,you must first know the business relationship that exists between youand the person performing the services. The person performing theservices may be-- An independent contractor. A common-law employee. A statutory employee. A statutory nonemployee. This discussion explains these four categories. A later discussion,Employee or Independent Contractor? (section 2), points outthe differences between an independent contractor and an employee andgives examples from various types of occupations. If an individual whoworks for you is not an employee under the common-law rules (seesection 2), you generally do not have to withhold Federal income taxfrom that individual's pay. However, in some cases you may be requiredto backup withhold on these payments. See Circular E for informationon backup withholding. Independent Contractors People such as lawyers, contractors, subcontractors, publicstenographers, and auctioneers who follow an independent trade,business, or profession in which they offer their services to thepublic, are generally not employees. However, whether such people areemployees or independent contractors depends on the facts in eachcase. The general rule is that an individual is an independentcontractor if you, the payer, have the right to control or direct onlythe result of the work and not the means and methods of accomplishingthe result. Common-Law Employees Under common-law rules, anyone who performs services for you isyour employee if you can control what will be done and how it will bedone. This is so even when you give the employee freedom of action.What matters is that you have the right to control the details of howthe services are performed. For a discussion of facts that indicatewhether an individual providing services is an independent contractoror employee, see Employee or Independent Contractor?(section 2). If you have an employer-employee relationship, it makes nodifference how it is labeled. The substance of therelationship, not the label, governs the worker's status.Nor does it matter whether the individual is employed full time orpart time. For employment tax purposes, no distinction is made between classesof employees. Superintendents, managers, and other supervisorypersonnel are all employees. An officer of a corporation isgenerally an employee, but a director is not. An officerwho performs no services or only minor services, and neither receivesnor is entitled to receive any pay, is not considered an employee. You generally have to withhold and pay income, social security, andMedicare taxes on wages you pay to common-law employees. However, thewages of certain employees may be exempt from one or more of thesetaxes. See Employees of Exempt Organizations (section 3)and Religious Exemptions (section 4). Leased employees.Under certain circumstances, a corporation furnishing workers tovarious professional people and firms is the employer of those workersfor employment tax purposes. For example, a professional servicecorporation may provide the services of secretaries, nurses, and othersimilarly trained workers to its subscribers. The service corporation enters into contracts with the subscribersunder which the subscribers specify the services to be provided andthe fee to be paid to the service corporation for each individualfurnished. The service corporation has the right to control and directthe worker's services for the subscriber, including the right todischarge or reassign the worker. The service corporation hires theworkers, controls the payment of their wages, provides them withunemployment insurance and other benefits, and is the employer foremployment tax purposes. For information on employee leasing as itrelates to pension plan qualification requirements, see Leasedemployees in Pub. 560, Retirement Plans for SmallBusiness (SEP, SIMPLE, and Keogh Plans). Additional information.For more information about the treatment of special types ofemployment, the treatment of special types of payments, and similarsubjects, get Circular E or Circular A (for agricultural employers). Statutory Employees Four categories of workers who are independent contractors undercommon law are treated by statute as employees. A driver who distributes beverages (other than milk) ormeat, vegetable, fruit, or bakery products; or who picks up anddelivers laundry or dry cleaning, if the driver is your agent or ispaid on commission. A full-time life insurance sales agent whose principalbusiness activity is selling life insurance or annuity contracts, orboth, primarily for one life insurance company. An individual who works at home on materials or goods thatyou supply and that must be returned to you or to a person you name,if you also furnish specifications for the work to be done. A full-time traveling or city salesperson who works on yourbehalf and turns in orders to you from wholesalers, retailers,contractors, or operators of hotels, restaurants, or other similarestablishments. The goods sold must be merchandise for resale orsupplies for use in the buyer's business operation. The work performedfor you must be the salesperson's principal business activity. SeeSalesperson in section 2. Social security and Medicare taxes.Withhold social security and Medicare taxes from statutoryemployees' wages if all three of the following conditions apply. The service contract states or implies that substantiallyall the services are to be performed personally by them. They do not have a substantial investment in the equipmentand property used to perform the services (other than an investment intransportation facilities). The services are performed on a continuing basis for thesame payer. Federal unemployment (FUTA) tax.For FUTA tax, the term employee means the same as itdoes for social security and Medicare taxes, except that it does notinclude statutory employees in categories 2 and 3 above. Thus, anyindividual who is an employee under category 1 or 4 is also anemployee for FUTA tax purposes and subject to FUTA tax. Income tax.Do not withhold income tax from the wages of statutory employees. Reporting payments to statutory employees.Furnish a Form W-2 to a statutory employee, and check "statutoryemployee" in box 15. Show your payments to the employee as othercompensation in box 1. Also, show social security wages in box 3,social security tax withheld in box 4, Medicare wages in box 5, andMedicare tax withheld in box 6. The statutory employee can deduct hisor her trade or business expenses from the payments shown on Form W-2.He or she reports earnings as a statutory employee on line 1 ofSchedule C or C-EZ (Form 1040). (A statutory employee's businessexpenses are deductible on Schedule C or C-EZ (Form 1040) and are notsubject to the reduction by 2% of his or her adjusted gross incomethat applies to common-law employees.) Statutory Nonemployees There are two categories of statutory nonemployees: directsellers and licensed real estate agents. They aretreated as self-employed for all Federal tax purposes, includingincome and employment taxes, if: Substantially all payments for their services as directsellers or real estate agents are directly related to sales or otheroutput, rather than to the number of hours worked and Their services are performed under a written contractproviding that they will not be treated as employees for Federal taxpurposes. Direct sellers.Direct sellers include persons falling within any of the followingthree groups: Persons engaged in selling (or soliciting the sale of)consumer products in the home or place of business other than in apermanent retail establishment. Persons engaged in selling (or soliciting the sale of)consumer products to any buyer on a buy-sell basis, adeposit-commission basis, or any similar basis prescribed byregulations, for resale in the home or at a place of business otherthan in a permanent retail establishment. Persons engaged in the trade or business of delivering ordistributing newspapers or shopping news (including any servicesdirectly related to such delivery or distribution). Direct selling includes activities of individuals who attempt toincrease direct sales activities of their direct sellers and who earnincome based on the productivity of their direct sellers. Suchactivities include providing motivation and encouragement; impartingskills, knowledge, or experience; and recruiting. For more informationon direct sellers, see Pub. 911, Direct Sellers. Licensed real estate agents.This category includes individuals engaged in appraisal activitiesfor real estate sales if they earn income based on sales or otheroutput. Misclassification of Employees Consequences of treating an employee as an independentcontractor.If you classify an employee as an independent contractor and youhave no reasonable basis for doing so, you may be held liable foremployment taxes for that worker (the relief provisions, discussedbelow, will not apply). See Internal Revenue Code section 3509 formore information. Relief provisions.If you have a reasonable basis for not treating a worker as anemployee, you may be relieved from having to pay employment taxes forthat worker. To get this relief, you must file all required Federalinformation returns on a basis consistent with your treatment of theworker. You (or your predecessor) must not have treated any workerholding a substantially similar position as an employee for anyperiods beginning after 1977. Technical service specialists.This relief provision does not apply to a worker who providesservices to another business (the client) as a technical servicespecialist under an arrangement between the business providing theworker, such as a technical services firm, and the client. A technicalservice specialist is an engineer, designer, drafter, computerprogrammer, systems analyst, or other similarly skilled worker engagedin a similar line of work. This rule does not affect the determination of whether such workersare employees under the common-law rules. The common-law rules controlwhether the specialist is treated as an employee or an independentcontractor. However, if you directly contract with a technical servicespecialist to provide services for your business rather than foranother business, you may still be entitled to the relief provision.See Employee or Independent Contractor? below.