It’s a common misconception: Are my workers employees or independent contractors? Some studies conducted at the state level reveal that at least one worker is misclassified as an independent contractor by 10-20% of employers.
It is crucial that you as a business owner properly assess whether individuals providing services for your business are independent contractors (self-employed) or employees. Generally speaking, employers withhold income taxes, Social Security and Medicare payments, and pay unemployment tax on wages paid to an employee. Employers generally do not have to withhold or pay any taxes on payments to independent contractors.
Before we discuss how you can classify your workers, let’s first clear the confusion between an independent contractor and an employee.
Who is an independent contractor?
An independent contractor, as defined by the IRS, is a payer who has the right to control the results of the job alone but does NOT have the right to what is going to be done and how. You are an independent contractor if you are self-employed.
If you are a gig worker, you are almost always considered an independent contractor.
For California employers, read more about the new Assembly Bill 5 that protects workers from misclassification in the state of California.
Here are a few examples of which individuals would be classified as an independent contractor:
- Contractors and subcontractors
- Public stenographers
- App-based workers (like Uber and Lyft)
Usually, any individual in an independent trade, company, or occupation in which they offer their services to the general public are independent contractors.
Who is an employee?
By common law rules, if you can monitor what is going to be done and how it is going to be done, anyone who provides work for you is your employee. Even when you give the employee freedom of action, what matters is that you have the right to control the details of how the services are performed.
How the IRS helps you decide.
Any proof of the degree of control and flexibility in the employer/worker relationship should be considered by small businesses. Worker classification depends on the facts in each case for considering whether a worker is an independent contractor or an employee.
This is why the IRS provides three categories to assist you in determining the classification of a worker. These categories are: Behavioral Control, Financial Control and Relationship of the Parties. Additional information and considerations on the three categories can be found here.
What happens if I misclassify an employee?
Classification of an individual as an independent contractor with no reasonable basis to do so makes employers responsible for employment taxes. Employers who can provide a reasonable basis not to recognize a worker as an employee may be able to avoid paying these taxes. For more information, click here.
Misclassified workers are often refused access to critical services and legal protections such as minimum wages, holiday payments, parental and medical leave, unemployment insurance, and safe workplaces.
Employee misclassification creates substantial losses in the form of lower tax revenues to the federal government and state governments, as well as to state unemployment insurance and pension programs for employees.
The effects of misclassifying an employee go beyond the employer paying penalties, the overall loss in tax money affects the government, taxpayers, and the economy.
For reclassifying workers as employees with partial exemption from federal employment taxes, click here to learn more about the Voluntary Classification Settlement Program.
Workers who claim that an employer wrongly identified them as independent contractors can use Form 8919 to determine and disclose the employee's share of uncollected Social Security and Medicare taxes due to their wages.
Other misclassification facts can be seen here.
For more information, take a look at the IRS fact sheet on understanding employee versus contractor designation.
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Disclaimer: Please note that this blog is not all-inclusive. Our guidance is designed only to give general information on the issues actually covered. It is not intended to be a comprehensive summary of all laws which may be applicable to your situation, treat exhaustively the subjects covered, provide legal advice, or render a legal opinion. Consult your own legal advisor regarding the specific application of the information to your own plan.