Recently, the IRS released a fact sheet to help remind small businesses of the importance of correctly classifying workers. Sometimes IRS lingo can be complicated, so we broke it down for you.
Let’s start with the question that’s probably going through your head – why does this matter?
When you classify your workers, this can help determine if you need to withhold income, social security and Medicare taxes. It also helps determine if you actually have to pay these taxes on employee wages. When it comes to independent contractors, businesses usually don’t have to withhold or pay taxes. If you’re not classifying correctly, you can get stuck with some harsh fines and penalties.
So how do you determine if the individual is an independent contractor or an employee? One general rule to follow is that your worker is an independent contractor if the business has the right to control only the result of the work, not how the work will be done. However, there are three categories that can help you make your determination.
A worker is considered an employee when the business gets to be bossy. Okay, maybe bossy isn’t the right word, but the business does have the right to direct and control the work being done. Behavioral control can be broken down into a few more distinct categories:
- Type of instructions – This can include telling the employee where to work, when to do the work and how the work should be done.
- Instruction complexity – The higher the complexity of the instructions given, the more likely it is the individual is an employee. When the instructions have less detail, this gives the worker more control to do the job how they see fit, which points towards the worker being an independent contractor.
- Evaluation – How a business evaluates the work can help determine if the worker is an employee or contractor. If the details of how the work was done are evaluated, then the worker is likely an employee. However, if only the end product is being evaluated, it’s more likely you have a contractor.
- Training – This one is fairly simple. Would you like someone else telling you how to do your job? If a worker is an employee, the business has the authority to do just that. For independent contractors, they are the experts and generally don’t require training from the hiring company.
Control over Finances
This category looks at what control the business has over the financial and business pieces of the worker’s job. Factors to consider include:
- Equipment investment – Independent contractors are much more likely than employees to make significant investments in the equipment they are using to get the job done. Employees are often provided equipment from their employer, rather than investing in it on their own.
- Expense reimbursement – Businesses generally reimburse expenses for their employees, not for independent contractors.
- Availability – Independent contractors generally have the freedom to seek out more business opportunities, while employees work is usually contained to the one business.
- Payment – This one is easy to understand. When you have employees, you usually guarantee them a regular wage. With independent contractors, a flat fee is usually agreed upon and paid on the completion of the work.
What the business or worker offers in the relationship can also determine classification. Some key elements to consider are:
- Contracts – Written contracts which describe the relationship the parties plan to create are a fairly simple way to determine which type of worker the business has. However, it’s important to note that a contract stating the worker is a contractor or an employee isn’t enough on its own to classify the worker’s status.
- Benefits – Insurance, retirement, vacation and sick pay are benefits provided to employees. It’s rare for these benefits to be given to independent contractors.
- Forever or just a fling – The length of time of the relationship can help determine a worker’s status. When an employee is hired, the expectation is that the relationship is long term. For contractors, the relationship isn’t permanent. Instead, both parties enter the relationship with the assumption of a certain amount of time for the work to be completed.
When businesses wrongly classify their workers, they are still liable for the related taxes and payments for those workers, and may even face other sanctions. Correctly classifying your workers helps you avoid this, making it easier for you to run your business.
We know this stuff can be kind of confusing – and even scary. But don’t fear! We are here to help.. just ask!