Employee or Contractor? It Pays to Know the Difference

An age-old question in business: is a worker an independent contractor or an employee? This seemingly simple question is often the contentious subject of numerous IRS audits in recent years. As an employer, getting this wrong could cost you plenty in the way of Social Security, Medicare and other employment-related taxes. Although taxes may be a primary concern, there may also be insurance or labor law ramifications for misclassified workers.

 

Here is what you need to know.

 

As the Worker:

If you are a contractor and not considered an employee you must:

 

• Pay self-employment taxes (Social Security and Medicare-related taxes)

 

• Make estimated federal and state tax payments

 

• Handle your own benefits, insurance and bookkeeping

 

As the Employer:

You must ensure your employee versus independent contractor determination is correct. Getting this wrong in the eyes of the IRS can lead to:

 

• Payment and penalties related to Social Security and Medicare taxes

 

• Payment of possible overtime, including penalties for a contractor reclassified as an employee

 

• A legal obligation to pay for benefits, including matching retirement plan contributions.

 

“Mutual agreement by the worker and the employer is not a valid indicator of the correct classification of the relationship,” says Julie Strohlein, CPA. “Although calling a worker an independent contractor may be cheaper and easier for the employer, and the worker may even agree to it, only the true facts and circumstances of the relationship determine the correct classification.”

 

Things to Consider

“This topic is always popular as both states and the IRS focus on this issue,” admits Chris Cicalese, CPA. “The best thing to do when unsure is to reach out to your CPA and have them take a look at your subcontractors to help identify potential issues.”

 

When the IRS recharacterizes an independent contractor as an employee they look at the business relationship between the employer and the worker. The IRS focuses on the degree of control exercised by the business over the work done and they assess the worker’s independence.

 

Here are some of their guidelines:

 

• The more the employer has the right to control the work (when, how and where the work is done), the more likely the worker is an employee.
• Adds Mike Engleman, CPA, “If the employer provides the tools, supplies, or materials to perform the work, the more likely the worker is an employee.”

 

• The more the financial relationship is controlled by the employer, the more likely the relationship will be seen as an employee and not an independent contractor. To clarify this, an independent contractor should have a contract, have multiple customers, invoice the company for work done, and handle financial matters in a professional manner.

 

• The more businesslike the arrangement, the more likely you have an independent contractor relationship.

 

Continues Julie, “Just because someone works for multiple employers doesn’t necessarily mean they are an independent contractor.  They could be an employee of each company simultaneously.

 

The amount of time the work takes and the amount the worker is paid for the work do not by themselves indicate the correct classification.

 

If a company frequently hires the same type of workers for the same type of tasks and is unsure of the proper classification, Form SS-8 can be filed with the IRS to ask for a determination.”

 

While there are no hard-set rules, the more reasonable your basis for classification and the more consistently it is applied, the more likely an independent contractor classification will not be challenged.

 

Companies should be sure to file the correct information returns for both classifications of workers.  Employees should be issued W-2s and independent contractors should usually be issued 1099s.  Failure to correctly file either type of form can lead to penalties.

 

 

Contact us for guidance and application to your individual situation à
The information contained in this newsletter is of a general nature and should not be acted upon in your specific situation without further details and/or professional assistance. For more information or for assistance with any of your tax or business concerns, contact our office at 856.667.4100.