Avoid Misclassification of Employees
Summer usually brings a wave of new hires to many businesses. From new graduates beginning their career, summer interns, or hiring additional help for projects that require extra assistance, it is important for employers to classify workers correctly. If a business misclassifies an employee without a reasonable basis, it could be held liable for employment taxes for that worker.
The IRS uses numerous factors to determine employee classification. Factors include evidence of the degree of control and independence and fall into the following three categories:
- Behavioral control,
- Financial control, and
- Type of relationship of the parties.
The two differentiators of behavioral control will show whether there is a right to direct or control how the worker does the work.
The general rule provided by the IRS is: an individual is an independent contractor if the payer has the right to control or direct only the result of the work and not what will be done and how it will be done.
The IRS defined an employee as: 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.
Additional behavioral control factor categories include:
- Type of instructions given
- Degree of instruction
- Evaluation systems
Financial control refers to facts that show whether or not the business has the right to control the economic aspects of the worker’s job.
The financial control factors fall into the categories of:
- Unreimbursed expenses
- An employee is usually reimbursed for expenses associated with their work where an independent contractor is more likely to incur expenses that are not reimbursed.
- Opportunity for profit or loss
- Having the possibility of incurring a loss indicates that the worker is an independent contractor.
- Services available to the market
- An independent contractor has the ability to seek out business opportunities advertise, maintain a business location and are available to work for several customers.
- Method of payment
- An employee will often have a regular wage for hourly, weekly, or other time periods. An independent contractor will often be paid an agreed upon fee for a project or job.
Understanding Business Relationships
To determine whether someone who is providing services is an employee or independent contractor, you must understand the business relationship between you and that person who is performing the service.
To determine whether an individual is an employee or an independent contractor under the common-law rules, the relationship of the worker and the business must be examined. In any employee-independent contractor determination, all information that provides evidence of the degree of control and the degree of independence must be considered.
How the worker and business perceive their relationship to each other depends on certain factors which generally fall into the categories of:
- Written contracts
- The IRS is not required to follow a contract that states a worker is an independent contractor, responsible for paying their own self employment tax. The IRS will base its decision in part by how the parties work together.
- Employee benefits
- Employer benefits such as insurance, pension plans, paid time off are usually provided to an employee, not an independent contractor.
- Permanency of the relationship
- If the worker will work for a specific project or period, that leans towards an independent contractor, if the worker remains working for an employer indefinitely, that will likely create an employer-employee relationship.
- Services provided as key activity of the business
- If a worker provides services that are a key aspect of the business, it is more likely that the business will have the right to direct and control his or her activities. If an employer (business) presents a workers work as its own, and controls or directs the work of the worker, the IRS would find this as an indicator of an employer-employee relationship.
Taxes for Independent Contractors (Self-employed)
An independent contractor will be required to pay income tax as well as self-employment tax on their net earnings. Self-employment tax is a tax consisting of Social Security and Medicare taxes primarily for individuals who work for themselves. Wage earners have Social Security and Medicare taxes withheld from their paycheck and matched by their employer.
As a self-employed individual, you may have to file Estimated Taxes quarterly. You can use these estimated tax payments to pay both your income tax and your self-employment tax liabilities.
Taxes for a Common-Law Employee
A common-law employee will often have a regular wage for hourly, weekly, or other time periods plus have withholding taxes taken out each pay period. In addition, an employer could provide health insurance benefits, life insurance, disability insurance and other benefits that would not be offered to an independent contractor.
Still Need Help with Employee Classification?
If you have questions regarding the classification of a worker, please contact us. We are available to answer your questions and assist at any time.
DISCLAIMER: The WM Update, WM Wednesday Wisdom, WM Daily Update, and other related communications are intended to provide general information, as of the date of this communication, and may reference information from reputable sources. Although our firm has made every reasonable effort to ensure that the information provided is accurate, we make no warranties, expressed or implied, on the information provided. As legislative efforts are still ongoing, we expect that there may be additional guidance and clarification from regulators that may modify some of the provisions in this communication. Some of those modifications may be significant. As such, be aware that this is not a comprehensive analysis of the subject matter covered and is not intended to provide specific recommendations to you or your business with respect to the matters addressed.