While knowing if your staff and workers are considered employees or independent contractors seems easy enough, there are situations in which the lines between the two can blur. However, the rules of business law, and the IRS, require that business owners determine how to classify their “workers” before issuing a payment for their services. In fact, if you get it wrong, your business could be responsible for paying back employment taxes for that individual(s).
Business Law – Employee vs. Independent Contractor
The quick-and-easy way to determine if a worker is an independent contractor or an employee is:
- Employees are told what work is to be done and how it is to be done
- Independent contractors are told what needs to be done, but they are free to decide how it will be done.
The law however, classifies a worker based on the evidence of the degree of control and independence the worker has over the work to be done. This evidence is categorized as:
- Financial: Who controls the business aspect of the work, such as how the work is paid for, if and how expenses are reimbursed, and who provides tools or supplies for the work?
- Behavioral: Who has control over what work is done and how the work is done? A worker is generally categorized as an employee if the business directs and controls the worker. Factors used to help determine behavioral control include:
- How instruction is given – employees are general told when, where and how to work
- How much instruction is given – the more instruction given generally points to the business having control over an employee
- Evaluations – employees are evaluated on how work is performed. Independent contractors are generally evaluated on the end result.
- Training – workers who are trained for a job, or are required to attend periodic or continuing training, are generally employees, as independent contractors generally use their own training and experience to complete a job.
- Relationship Type: Are there written contracts between the worker and payer? Are there employee benefits, such as health insurance, pension plans, vacation pay? Is the work being performed key to the business and will the relationship continue?
Business owners are tasked with weighing each of these factors when determining how to classify workers. While some of this factors may point to the worker being an employee, other factors may indicate the worker is an independent contractor. Unfortunately, there are no set guidelines for determination for some types of businesses.
Independent Contractor or Employee? IRS Form SS-8
It is important that business owners carefully consider each piece of evidence and document the results of each factor and how the determination was made. If after reviewing the evidence, a conclusion cannot be made, you can file Form SS-8 – Determination of Worker Status for Purposes of Federal Employment Taxes and Income Tax Withholding, with the IRS, who will then determine how the worker is classified. Be aware, it can take up to six months for the agency to make a determination.
Legal Repercussions for Misclassified Workers
If you categorize an independent contractor as an employee, you will probably pay more for labor (including overtime), file state and federal taxes, withhold Social Security and Medicare, pay into unemployment insurance, etc. It’s a costly mistake for the business.
If you misclassify an employee as an independent contractor, you may have to pay them for wages that you should have paid, pay back taxes plus penalties, and you may have to pay worker’s compensation benefits if they get injured, and provide the employee with any employee benefits offered by your business.
If you have determined that your worker is an independent contractor, then you must have them file out Form W-9 – Request for Taxpayer Identification Number and Certification. This form should be kept in your records for any future needs.
The independent contractor will use Form 1099-MISC to report their earnings to the IRS. Your business must send the independent contractor a completed copy of Form 1099-MISC if you paid them more than $600 in a year for their service. You must send the Independent Contractor the form prior to January 31. You must also send a copy of the form to the IRS by February 28.
If you have determined that you worker is an employee, you must:
- Withhold Federal Income Tax from their paycheck
- Withhold Social Security and Medicare Taxes from the employees’ wages. Your business will match the amount withheld
- Withhold the Additional Medicare Tax from employee wages, though you will not match this tax
- Report and pay Federal Unemployment Tax (FUTA) from your business funds (employees do not pay FUTA and it is not withheld from their wages
Correctly identifying your workers as employees or independent contractors can help your business run in a more cost-effective manner, while preventing you from having to pay hefty penalties and back wages and taxes.