An independent contractor relationship can be mutually beneficial for both the worker and the employer. The worker, whom the Internal Revenue Service (IRS) considers self-employed, decides which clients and projects to take on and how much time to devote to each. He or she also has much more leeway when negotiating rates since the employer pays no benefits.
It’s advantageous from the employer’s perspective because the company doesn’t have to withhold any taxes, pay benefits, or contribute towards workers’ compensation or unemployment insurance on the employee’s behalf. The only obligation to independent contractors is to send a Form 1099-MISC to anyone who earned over $600 in a calendar year. Because of this, some employers look to cut corners and deliberately classify workers as independent contractors when they’re actually employees. Other employers make the mistake due to lack of knowledge.
Regardless of how it happens, the IRS pays close attention to business tax returns that claim payments to several independent contractors. Your company could be subject to fines as well as the requirement to pay employment taxes for all employees whom it misclassified.
Three Rule Categories to Determine Employee vs. Independent Contractor
According to the IRS, they should apply these three common law rules to each situation:
- Does the company control the worker’s scheduled hours, how much work he or she completes in a day, the location where he or she completes the work, or the specific steps used to complete the work? If so, this person is an employee and not an independent contractor. When in doubt, consider how much control your company has over the worker’s behavior. The greater the control, the more likely it is that the person is an employee of your company.
- How many business aspects of the worker’s job does your company control? For example, does the worker supply his or her own tools such as computer and software programs or does the company do that? Does the company reimburse any expenses? The worker is an employee if your company controls most or all financial aspects of the working relationship.
- Do you expect the business relationship to go on indefinitely? Do you offer any types of benefits to this person? If so, it’s important to classify him or her as an employee.
Use IRS Resources for Additional Clarification
If you still feel uncertain about how to classify workers, you can complete IRS Form SS-8 and it will make the determination for you. The name of this form is Determination of Worker Status for Purposes of Federal Employment Taxes and Income Tax Withholding. Workers have the right to file the same paperwork if they feel your company has misclassified them and they’re entitled to benefits or not to have the obligation to pay self-employment tax.
Get Additional Tax Help from Chicagoland CPAs
Maybe you’re clear on how to classify workers but have other payroll tax questions. Whatever your situation, we’re here to help. Please contact us to request a consultation with a small business accountant.