Classifying workers: employee or contractor?

Your Guide to State, Local, Federal, Estate + International Taxation

classifying workers, employees, contractorsEvery business with employees and independent contractors should periodically review the status of workers to see if they’re properly classifying workers. Employees must have federal income and Social Security taxes withheld. Matching Social Security taxes and federal unemployment taxes are paid by the employer on employee wages. Employees are also eligible for fringe benefits and retirement plans. There may be state obligations as well.

On the other hand, these rules do not apply to independent contractors. Contractors receive checks for their services and receive a 1099-MISC at the end of the year reporting their total earned income amount.

The IRS developed a “common law,” which states a worker is generally classified as an employee if the employer has the right to control and direct the worker regarding the work he or she is doing and how he or she does it.

Implications of misclassifying workers

Review the questions listed below – if you answer yes to these questions, there is a good possibility you have an employee rather than an independent contractor.

  • Does the worker have to comply with instructions about when, where and how he or she is to work?
  • Does the worker receive ongoing training from an experienced employee that shapes how he or she performs the work?
  • Are the worker’s services integrated into the business operations?
  • Do the services have to be rendered personally?
  • Does the employer hire, supervise and pay assistance for the worker?
  • Is there a continuing relationship between the worker and the employer?
  • Is there a requirement for the work to be performed on the business’s premises?
  • Is the work performed by the worker required to be performed in a specific order or sequence?
  • Is the worker required to submit regular or written reports?
  • Is the worker paid by the hour, week or month?
  • Does the business provide tools, materials and other equipment and pay business and travel expenses for the worker?
  • Does the employer have the right to fire the worker?

There are also special indicators for independent contractors. Review the questions listed below – if you answer yes to these questions, you are probably working with an independent contractor.

  • Does the worker invest in facilities that aren’t typically maintained by an employee?
  • Can the worker realize a profit or loss as a result of the services performed?
  • Does the worker perform more than minimal services for several unrelated businesses at the same time?
  •  Does the worker make his or her services available to the public on a regular and consistent basis?

There is no exact answer for how many of these tests must be satisfied to indicate employee or contractor status for classifying workers. You may have instances where a worker falls partially in both categories. Feel free to contact your CPA at Henry+Horne if you have any questions regarding your workers’ classifications. Our tax professionals help clients in a variety of industries including construction, dealerships, restaurants, technology and more.

KC Kolb