Businesses must examine the relationship between it and the worker to determine if the worker is an employee or a contractor. Distinguishing between these two is important to determine if an employer must withhold income taxes and pay Social Security, Medicare taxes, and unemployment tax wages paid to an employee. Generally, the rule is that an individual is a contractor if the payer has a right to control or direct only the result of the work, not what will be done or how it will be done. To better determine how to properly classify a worker, the IRS asks that you consider these three categories:
Behavioral Control
A worker is an employee when the business has the right to direct and control the work performed by the worker, even if they don’t exercise that right. The categories that fall under behavioral control are:
- When and where to work, what tools to use, where to purchase supplies and services, etc. If a business gives these types of instructions, chances are, the worker is an employee.
- If instructions are more detailed it may indicate that the worker is an employee. Fewer direction means less control and the worker may be a contractor.
- Does the business use evaluation systems to measure the details of how the work is done? This would mean the worker is likely an employee.
- Is there on-the-job training? If yes, this is a strong indication the worker is an employee.
Financial Control
If the business controls the financial and business aspects of the worker’s job, they may be an employee. Consider these points:
- If the company invests significantly in the equipment the worker uses for someone else, they are likely an employee.
- If there are unreimbursed expenses, contractors are more likely to incur those than employees.
- Is there an opportunity for profit or loss? If yes, the worker is likely a contractor.
- Is the worker free to seek out other business opportunities of this same type? If no, they are most likely an employee.
- Do you pay a regular wage for an hourly, weekly, or commission? Then your worker is probably an employee. If you are paying for a specific project, they may be a contractor.
Relationship
The perceived relationship between the worker and business often indicates the classification of the worker. This may include:
- Written contracts describing the relationship between the parties. However, a contract stating a worker is an employee or contractor is not sufficient to classify a worker’s status.
- Benefits. If your business provides benefits, you are likely hiring an employee. Benefits are not usually extended to contractors.
- Is your relationship permanent? If you believe the relationship will last indefinitely as opposed to a specific period of time, you may be hiring an employee.
- Services provided are a key activity of the business. If the services the worker provides are a key aspect of the regular business of the company, you should classify them as an employee.
Consequences of Misclassification
If you accidentally classify a worker as an independent contractor and it is later discovered, your business will be liable for employment taxes. The IRS can help you determine the status of your workers with Form SS-8, Determination of Worker Status for Purposes of Federal Employment Taxes and Income Tax Withholding. IRS Publication 15-A, Employer’s Supplemental Tax Guide, is also a great resource.
If you have any additional questions or concerns about your workforce, please, reach out to us at Sound Accounts! We would love to help and “our strength is YOUR numbers!”
