The biggest reason to define the difference between employee and a contractor is for tax purposes, to ensure contributions and income withholding comply with employment standards. The definition of employee or contractor can make a big difference tax-wise so it’s important to not only know the differences, but classify the relationship correctly.
It can get a little more complicated for companies in multiple countries. So how does this relationship differ in Canada from the United States? There are some differences between the countries, but the differences are not huge. In general, both countries have similar definitions, criteria, and types of payroll withholding, but with their own definitions and forms. In this post, we will go over and highlight the differences between Canada and the US when defining the employee and contractor relationship.
Both countries have broad definitions of an employee, however in broad terms, they both define an employee by the amount of control a business has over the person’s work. The more control a business has over the person’s work, the more likely that person is an employee.
According to the Employment Standards Act in Canada, the definition of an employee is the following:
- A person, including a deceased person, receiving or entitled to wages for work performed for another,
- A person an employer allows, directly or indirectly, to perform work normally performed by an employee,
- A person being trained by an employer for the employer’s business,
- A person on leave from an employer, and
- A person who has a right of recall.”
In the US, the definition of an employee from the IRS is:
“Under common-law rules, anyone who performs services for you is your employee if you can control what will be done and how it will be done. 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 how the services are performed.”
Just as defining whether it is an employee or contractor relationship differs in Canada from the United States but has a similar basis, the same is true for the criteria used in each country. Both countries establish a contractor relationship as one where the worker is independent in conducting their work from the employee; they just have different ways of measuring it.
Canadian criteria for defining the employee-contractor relationship
As seen in the table above, the province of Quebec has slightly different standards from the rest of Canada. You can view the criteria from the CRA for both Quebec and the rest of Canada in more detail here.
American criteria for defining the employee-contractor relationship
- Behavioural – Does the company control or have the right to control what the worker does and how the worker his or her job?
- Financial – Are the business aspects of the worker’s job controlled by the payer? (these include things like how the worker is paid, whether expenses are reimbursed, who provides tool/supplies, etc.)
- Type of relationship – Are there written contracts or employee type benefits (i.e. pension plan, insurance, vacation pay, etc.)? Will the relationship continue and is the work performed a key aspect of the business?
If the answer is “yes” to all of these points of the American criteria, then the worker is an employee. You can view more information on the IRS’ criteria here or by clicking on the title links for each section for more information specifically on that criteria point.
Still unsure it it’s a contractor or employee relationship?
In Canada and the US, either the business or worker can request that the governing tax body determine whether it is an employee or contractor relationship by filing a specific form.
Tax Obligations OR income withholding and Forms
In either country if the person is a contractor, they won’t receive any benefits from payer, nor will the payer withhold any taxes from the person’s pay. Canadian and American employers are legally obligated to deduct pay, make contributions, and remit payroll deductions for their employees. These deductions include income taxes, benefit premiums, and pension contributions. Businesses do not do these for the contractors they have hired because by definition, these contractors are employers themselves so they must take care of their own deductions.
Below we have summarized the tax obligations and related forms in Canada and the US depending on whether it is an employee or contractor relationship.
Consequences for Misclassifying an Employee
In both countries, there are monetary penalties for misclassifying a person as contractor instead of an employee.
In Canada, failure to properly identify an employee as an employee would result in the employer having to pay the now outstanding payroll deductions for the employee in addition to penalties, interest and legal fees.
In the US, the penalty for misclassifying an employee depends on if it was on a reasonable basis. If it is deemed that the misclassification did happen on a reasonable basis, you may be relieved from having to pay the taxes for that worker. If you have no reasonable basis for the misclassification, then the employer may be held liable for employment taxes for that worker.
It’s important to classify the employee contractor relationship correctly or seek out another opinion if you’re unsure because it could save you from headaches, wasted time and possibly having to remit hundreds of dollars. If you’re looking for a payroll solution that can help you automatically deduct the proper amounts for defined employees and contractors in both Canada and the US, contact us here to learn more about Advanced Payroll AX. We look forward to hearing from you!
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