Classifying a Worker as Employee or Contractor

IRS Worker Classification: Should Company Individuals Be An Employee Or A Contractor

The majority of businesses would like to categorize workers as contractors and not employees. After all, contractors are far easier and cheaper. For contractors, there are no taxes to be withheld, no benefits, unemployment insurance and workers’ compensation to pay for and businesses don’t have to observe with hour and wages laws.

IRS Ground Rules: Employee vs. Contractor - What Is The Difference?

There are three factors the Internal Revenue Service lays out in regards to who is and is not an employee:

1 – Does the employer have control over the worker’s behavior and how the worker carries out the tasks of the job?
2 – Does the employer have control over the worker’s finances? Does the worker have his/her own business, with other clients and not dependent upon the employer?
3 – What is the relationship of the parties? A contractor tends to work on several projects at once, not one open-ended job and a contractor doesn’t always offer core services that companies tend to offer their customers.

In the majority of businesses, and using the three factors above, most hired workers are employees, not contractors. There are some exceptions to this rule such as service providers:

- Attorneys
- Accountants
- Web designers

These are people who tend to work independently and work with various other clients. Of course, this isn’t always so cut and dry. An accounting firm who hires a CPA to do the tax returns for clients is an employee.

Before you incorrectly classify someone in your company, be sure to look over the IRS Section 530 to be sure you’re in compliance. You should never change the status of an employee to contractor without a serious alteration in their job duties. If you have workers who do the same job, you cannot claim some as an employee and others as a contractor.  File all your tax returns on the basis of a contractor classification.

Some Helpful Advice

Businesses should classify their hired workers as employees, unless it is obvious the worker is a contractor. After all, classifying them wrong could be risky and outweigh any benefits you could attain. If caught by the IRS, you could be forced to pay back a ton of money in terms of:

- Overtime
- Payroll taxes
- Workers’ compensation

This is an addition to any interest and penalties levied against your company.

These penalties could be what hurt your company the most. The IRS will assess penalties based upon the agency’s opinion of you and your company. If they believe you were not intending to be dishonest, the penalties could be around 20 percent the FICA that ought to have been withheld and 1.5 percent the wages. However, if the IRS feels you were being deliberately deceiving, you could be held responsible for all of it.  Worst of it all, there is no corporate shield to protect you from the agency’s wrath.

Will You Get Caught Cheating The IRS

There’s no guarantee that you will or will not be busted by the IRS. Just remember that the IRS makes a good deal of its money from misclassifications. So, along with an expensive computer software program, it has the incentive to catch cheaters. And, remember, if you have an employee dispute and they know of your cheating, they could turn this information in to the IRS.

If you decide to reclassify your contractor to an employee, you should do it before Jan. 1 of the next year. This means a worker will not get a 1099 and W-2 for the same year for the same job, which could result in an audit.