Job search sites are filled with listings for part-time workers, temporary positions, freelance workers and independent contractors. But these job classifications are not interchangeable, and misclassifying a worker as an independent contractor comes with penalties and possible lawsuits.
The rise in the use of independent contractors is a remnant of the 2007 – 09 recession. Declining profits pushed struggling organizations to lay off employees, explains workforce.com. But rather than lose these valuable workers, companies simply rehired them as independent contractors—eliminating the need to provide employee benefits, overtime, etc., and helping these companies navigate the ups and downs of business.
But, the IRS has a specific set of rules regarding independent contractors and taxes. “You must withhold income taxes, withhold and pay Social Security and Medicare taxes, and pay unemployment tax on wages paid to an employee. You do not generally have to withhold or pay any taxes on payments to independent contractors.” (Independent contractors are paying their own taxes.)
IRS classification rules for independent contractors
The decision of whether a worker is an employee or an independent contractor isn’t simply up to the hiring organization. The IRS also has rules to help you determine whether a worker qualifies as an independent contractor.
A worker is classified as an independent contractor if the paying organization only controls the results of the work and not how the work will be done. “Anyone who performs services for you is an employee if you can control what will be done and how it will be done.” Even an experienced worker who is given greater freedom with how they perform their work is still considered an employee, however. While classification factors overlap, they fall into three basic categories: Behavior control, financial control and type of relationship.
Behavioral control. Is the organization giving instructions to the worker about when, where and how to work? If the organization has the right to control when to work, what equipment to use, what additional workers can help the worker in question, where to purchase supplies or establishes a sequence of steps, then the person would be classified as an employee. If an organization has given up the right to control the details of a worker’s performance, the individual is an independent contractor. An independent contractor usually uses his or her own methods, rather than being trained by the employer.
Financial control. Is the organization reimbursing the worker for expenses? “Independent contractors are more likely to have unreimbursed expenses than are employees. However, some employees do also have unreimbursed expenses in connection with their jobs.
- Does the worker have the freedom to work with other businesses? Independent contractors may have a separate business location and be available to work for other organizations.
- How is the worker paid? Generally, an employee receives a regular wage amount or hourly rate. Independent contractors generally receive a flat amount based on the job. (This is not a hard and fast rule as in certain professions, independent contracts do make an hourly wage.)
- Can the worker make a profit or loss? An independent contractor can realize a loss, whereas an employee couldn’t.
Type of relationship. This can be determined by contracts describing the relationship, whether the worker is given benefits, permanency of the relationship and how integral the services are to the core of the business. If a worker receives insurance, participates in the pension plan, gets vacation pay, etc., he or she is probably an employee. If the relationship continues indefinitely, the worker would seem to be an employee also. And, if the work being performed is key to the regular business activity, the worker would probably be categorized as an employee.
Penalties, back taxes and lawsuits by former employees can all come from misclassification of independent contractors. Closely examine your organization’s relationship with a worker to determine whether that worker is an independent contractor or an employee. It’s important to understand the IRS regulations, as well as the regulations governing your state. If you’re uncertain, you can file IRS Form SS-8 and the IRS will give you an official determination.