One of the most common questions I am asked by clients is how to determine whether a worker should be categorized as an employee and added to payroll or as an independent contractor. It’s important to understand the difference as there are consequences to misclassification. The key is that to be considered an independent contractor there must be a certain degree of control and independence. Examining this can be challenging but the IRS outlines three categories to help an employer make the right choice. They are as follows:
- Behavioral: Does the company control or have the right to control the work and how it is performed? For example, does the worker provide their own equipment and supplies? Can they hire their own helpers? Can they set their own schedule?
- Financial: Are the business aspects of the worker’s job controlled by the employer? Does the employer determine how and when a worker is paid or does the worker make that determination? Does the worker submit an invoice?
- Relationship: Is there a written contract between the worker and employer? Is the worker eligible for benefits such as health insurance or paid vacation? Is the work temporary? Is the worker an essential part of the operations of the business?
If a worker is determined to be an employee, the employer must pay all appropriate taxes such as state and federal unemployment, Social Security and Medicare taxes, etc. Your employee should complete a Form W4 at the start of work along with any other necessary new hire forms and a W2 is issued at the end of the year to properly report their wages.
Typically, no tax needs to be withheld from an independent contractor and any wages of $600 or more are instead reported on a Form 1099 at the end of the year. For all subcontractors, be sure to obtain a completed Form W9 at the start of work.
If it is determined that a worker has been misclassified without any reasonable explanation for doing so, the employer may be held liable for past employment taxes for that worker so be sure to carefully consider all factors before making a decision.
