Employers are under more scrutiny than ever when it comes to wrongly classifying employees as independent contractors to avoid paying employee benefits. The federal government has been conducting audits to determine if employees are being misclassified. Knowing the difference between independent contractors and employees will help you avoid costly legal consequences.
How to classify workers
Let’s take a look at some questions to ask before you classify a worker as an independent contractor:
* Do they have a business license?
* Do they have a business location?
* Do they have their own equipment, materials and tools?
* Do they have other clients or are they solely dependent on your company’s business?
* Do they do the same job as your employees?
In addition to these criteria, the IRS considers three categories when classifying independent contractors: behavioral control, financial control and type of relationship.
This refers to whether your business has a right to direct and control what work is accomplished and how the work is done through instructions, training or other means.
This refers to whether the business has a right to direct or control the financial and business aspects of the worker's job. This includes:
* The extent to which the worker has unreimbursed business expenses
* The extent of the worker's investment in the facilities or tools used in performing services
* The extent to which the worker makes his or her services available to the relevant market
* How the business pays the worker
* The extent to which the worker can realize a profit or incur a loss
Type of relationship
This refers to the relationship between you and the worker in question, including:
* Written contracts describing the relationship the parties intended to
* Whether the business provides the worker with employee-type benefits, such as insurance, a pension plan, vacation pay or sick pay
* The permanency of the relationship
* The extent to which services performed by the worker are a key aspect of the regular business of the company
Consequences of misclassifying workers
Incorrectly classifying employees as independent contractors means you will be required to pay a percentage of the income taxes that should have been withheld from employee wages. You will also be held responsible for your share of FICA and unemployment taxes, plus penalties and interest. In addition, you could be putting your business at risk for wage and hour lawsuits.
Protect your company from liability
Here are five ways to protect your company from employee misclassification liabilities:
- Make sure there is a written contract in place for each independent
contractor. The contract will include an explanation for their
classification as an independent contractor.
- Include a statement that they are not entitled to company benefits.
- All independent contractors receive a Form 1099 as required by the
- Regardless of whether the worker is an employee or independent
contractor, be sure to obtain their full name, address and Social
Security number before you pay them.
- Document the factors you use to determine the worker's classification in case there is a later dispute.
The IRS will assist you in determining whether a worker is an independent contractor or an employee: just file Form SS-8. However, you should treat the worker as an employee until you receive a decision from the IRS.
For more information, read this IRS publication about employee classification, or refer to the IRS Independent Contractor Checklist, or watch a webinar explaining the impact of misclassification on wage and hour law with attorney Seth Briskin.
Paycor can help you with employee classification and other HR questions through our HR Support Center, a comprehensive, low-cost online resource full of checklists, templates, and HR advice that can save you time and money while protecting your business from costly mistakes. Contact us to learn more.
Paycor Expert Arlene Baker has 35 years of payroll experience and more than 20 years of experience with Paycor. Arlene is a veteran member of her local American Payroll Association chapter and the 2003 winner of the Ohio Payroll Professional of the Year award.
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