Classifying workers is not just for big companies. Small businesses also hire both employees and independent contractors to provide specific services for their business. But, if an employer "misclassifies" an employee, the company can be held liable for the taxes of that employee.
Knowing the difference between an independent contractor and an employee can help prevent future headaches and problems, but what is the difference?
An employee is usually a worker who is paid a regular wage, performs services for a company, and has structured tasks and schedules. They do not worry about their own taxes as they are deducted payroll taxes on their wages, and the employer will generally provide benefits to the employee.
An independent contractor typically gets paid a flat rate or per project. They dictate their hours and can work for multiple employers. Independent contractors can be hired for long-term or short-term projects. Usually, the IRS identifies them as "self-employed" and must file self-employment taxes for tax purposes.
The IRS has tax tips to ensure that employers understand how to categorize their workers. These tax tips are not a "magic" solution to determine a worker, but they are good guidelines for classifying them. Here are the three categories according to the IRS:
Behavioral control is about the amount of power an employer has over a worker's day. If an employer trains a worker, gives them specific hours or tasks, and dictates how the work is being done, they are most likely an employee.
An independent contractor will have more say over their hours and how the task is done. This is usually determined during the initial meeting of the project or service.
Financial control would be determined by how the worker is paid. If the worker is paid a regular wage and the employer makes sure payroll taxes are withdrawn from every check, the worker is most likely an employee.
The opposite is said for an independent contractor. The contractor makes their own rates and is usually paid per project. They are responsible for reporting their own taxes.
Relationship to the Parties
The employer's relationship with their worker can also help classify them. If the worker is provided benefits such as insurance and vacation time or has a more continually type relationship with the employer, they are most likely an employee.
If the worker completes projects here or there or is only hired for a single long-term project with no benefits provided by the employer, they are most likely an independent contractor.
All these factors must be considered when classifying an employee. If an employer is unsure if the worker is either an employee or an independent contractor, they can provide the IRS with the information they have gathered from the list above by filling out Form SS-8. One should note that this process could take up to six months to receive an answer.
Misclassifying an Employee
Misclassifying an employee can lead to consequences for any business. An employer often does not know where a worker fits in the three categories listed above. On some occasions, it can be because an employer is trying to opt-out of paying the taxes and benefits an employee would typically receive. Either way, misclassifying an employee can cause the IRS to look for the taxes an employee is supposed to pay.
If a worker believes they were misclassified, they can use Form 8919 and document their share of uncollected Social Security and Medicare taxes due.
For more information, please can visit the IRS website.