The question of whether workers are employees or independent contractors has made the news as recent startups publicly deal with the question. But it’s an important one for anyone who hires independent contractors for many reasons, including the possibility of paying steep fines and taxes if it turns out you’ve misclassified an employee.
“Aside from the labor laws that you may be violating if you incorrectly classify your workers, the IRS is aggressively pursuing companies in order to collect back Social Security and Medicare taxes for misclassified employees,” John Hewitt writes for inc.com. “The employer portion of the Social Security tax is 6.2 percent and the Medicare tax is 1.45 percent. In addition, there is the federal unemployment tax and the state unemployment tax that can be more than 10 percent, depending on your state. Workers compensation insurance also varies from state-to-state.” And if your independent contractor claims he or she is an employee, you could be looking at a payroll audit of your entire company.
So, how can you tell if the person turning in work for you is an employee or a contractor?
One major factor is control, writes Kelly Phillips Erb for forbes.com. “The more likely you are to control the terms of the employment, the more likely you are an employer,” she writes. “If, as the employer, you control how the worker performs his or her job, chances are that the worker is an employee.”
Other factors include how workers’ expenses are handled and who’s investing in specialized equipment to allow the worker to perform his or her job. Earlier this year, the U.S. Labor Department’s Wage and Hour Division issued guidelines detailing the standards organizations should use to determine whether a worker should be considered an independent contractor or an employee.
The IRS has similar guidelines, as well. “The standards are partly based on an economic realities test that can help show if an individual is economically dependent on an employer or in business for him or herself,” Michelle Rafter writes for the OC Register.
So what should you do if you’re suddenly unsure about whether your workers’ classifications are correct? “If there is any doubt in either your mind or the worker’s mind… file Form SS-8 to request a determination of worker status under the common law rules for purposes of federal employment taxes and income tax withholding,” Hewitt writes.
And make sure you include your tax professional on this process, Erb advises. “The IRS offers a Voluntary Classification Settlement Program that allows employers to reclassify workers as employees for future tax periods,” she writes, “and obtain some tax relief.”