Employee VS. Contractor
Recently I received a call from a client saying he wanted to “help” his employees and have them all be independent contractors. He felt this was a “win-win” because his employees could write-off unreimbursed expenses that were lost with the passage of the Jobs Act and he can save money on payroll taxes, insurance, etc.
What is the definition of an independent contractor? The general rule is the payer cannot direct what is done and how it is done. They only control the results of the work.
The Internal Revenue Service has come up with three categories to consider in determining whether someone is a worker – Behavioral Control, Financial Control and Relationship of the Parties.
Behavioral Control: Does the business have the right to direct and control the work performed. Do you tell them when they start the job and when they finish? Are you supplying the tools and equipment? Do you give them detailed instructions on how to perform the job?
Financial Control: Does the business have the right to control the financial aspects of your job. Do you pay for everything on behalf of the worker? Reimburse them for automobile usage? For supplies? Do you guarantee a regular wage even if supplemented with commission? Do you not allow them to market their services to others?
Relationship: This is the interaction between the business and the worker. Do you provide an employment agreement for them to sign? Having them sign an independent contractor agreement does not make them an independent contractor. Is the job for indefinite period rather than on a job to job basis? Are their job duties critical to the success of the business?
If you answered yes to any of the above, the person you hired is likely an employee.
For further resources to help businesses determine whether they are an employee or independent contractor, the IRS has the following resources: Form SS-8, Determination of Worker Status for Purposes of Federal Employment Taxes and Income Tax Withholding and IRS Publication 15-A Employers Supplemental Tax guide are great resources.
A mistake in classification can be quite costly. Per netPolarity, they can be as high as “41.5% of the contractors’ wages. And these penalties can go back for three years.” The IRS may seek criminal conviction of one year in jail and a fine as high as $500,000 if they think you intentionally misclassified workers. The independent contractor is at risk for audit and may be forced to repay any business deductions and Section 199A taken. The US Department of Labor will require you to pay back wages for up to three years and levy fines for improper recordkeeping. The company will also get an audit which may uncover other wage and hour violations.
So, I ask you, is it really a “win-win” situation?