Workers Classification – Employees or Independent Contractors
As a business owner or an employer, when you hire a new worker, you will be reintroduced to the question – should you classify the worker as an employee or an independent contractor? In order to make this huge business decision, you need to fully understand the difference between an employee and an independent contractor and the importance of classifying them correctly.
Difference between an employee and an independent contractor
As a general rule, a worker is classified as an employee if you – as an employer – have the right to supervise what job will be done, how it will be done and the method of accomplishing the result. On the other hand, independent contractors retain absolute control over the manner and means of how the job will be performed.
There are three key areas that the Internal Revenue Service (IRS) looks at in order to determine the distinction between an employee and an independent contractor. These are:
- Behavioral control: Does the employer have the right to direct or control all aspects of the job such as when, where and how the job is to be performed?
- Financial control: Does the employer has control over all financial-based business aspects such as whether or not expenses are reimbursed, how and when the worker is compensated, the extent of worker’s investment in the amenities used in the job, type and cost of benefit packages, and any other financial matters pertaining to the job?
- Type of relationship: The IRS examines the working relationship between the employer and the worker through written contracts detailing whether the worker is eligible for benefits such as insurance, a pension plan, vacation or sick pay and if this relationship extends beyond the duration of the job or not.
Some employers wrongly classify their employees as independent contractors in an attempt to avoid the expenses associated with retaining employees – namely, payroll taxes, minimum wage or overtime requirements as well as other wage and hour law requirements like providing meal periods and rest breaks, and reimbursable business expenses employees incur in performing their jobs.
The Cost of Misclassification
While it is true that the expenses associated with employees are high, the cost of misclassification is even higher. Worker misclassification is on the radar of every government agency out there, including IRS, Department of Labor (DOL), Unemployment Agency and Department of Treasury, all of whom are eager to find additional revenue sources these days.
If you are caught misclassifying your workers (either intentionally or unintentionally), you could face some serious legal and financial consequences. You will not only be required to reimburse various employee-related payments like unpaid wages, overtime wages, workers’ compensation benefits, retirement contributions, employee benefits, Medicare and Social Security contributions, unemployment insurance, health insurance and back taxes but you may also be required to pay the stiff penalties and interest that can be imposed by both federal and state agencies for violating the various laws (such as Fair Labor Standards Act (FLSA), Immigration Reform and Control Act (IRCA), Family and Medical Leave Act (FMLA) and Workers’ Compensation Act). For example; every instance of willful misclassification can be fined for up to $25,000.
The U.S. economy is actually doing pretty well presently, but it is yet to find its footing. It goes without saying that you may definitely save money upfront by classifying your employees as independent contractors, but you could end up paying much more in the long run if they are ever reclassified (either through a complaint filed with DOL or an unsolicited audit from IRS).
Protect yourself by thoroughly analyzing each individual working relationship to make sure every single worker is correctly classified. If you are still unsure, submit form SS-8 and the IRS will make the final determination of your worker’s status. Knowing you are on the right side of the law will give you the peace of mind to continue running your business.