Employee or Independent Contractor?
by Barbara Joyce
For many small businesses, especially in this economy, it is tempting to treat workers as independent contractors to save money. When workers are classified as employees, employers must pay Social Security, Medicare, and Unemployment Insurance for each employee. Most employers must also pay Workers' Compensation insurance, not to mention the added time or expense to prepare federal and state payroll reports (i.e., 941, 940, W-2). The only additional time or expense for workers classified as independent contractors is issuing a 1099 at the end of the year, and only if the employer paid the independent contractor more than $600 during the course of the year. So, of course small business owners want to classify workers as independent contractors. It saves money, time, and reduces headaches.
As a small business owner myself, I really do understand the temptation, but unfortunately, the classification of workers as employees or independent contractors is determined by law, not by choice of workers or business owners. That said, business owners need to be aware of the consequences. According to the IRS:
“Consequences of Treating an Employee as an Independent Contractor
If you classify an employee as an independent contractor and you have no reasonable basis for doing so, you may be held liable for employment taxes for that worker .... See Internal Revenue Code section 3509 for more information.”
In other words, an employer could be responsible for paying 15.3% of that “employees” gross pay for the entire time the employee was misclassified, if the employer had no reasonable basis for classifying a worker as an independent contractor.
Making the determination is not always as simple as it might seem. The courts consider many facts to make a determination. The relevant facts fall into three categories: behavioral control; financial control; and relationship of the parties.
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Behavioral Control: Does the company control or have the right to control what the worker does and how the worker does his or her job? If the worker receives extensive instructions on how the work is to be done, this suggests the worker is an employee.
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Financial Control: Are the business aspects of the worker’s job controlled by the payer? (these include things like how worker is paid, whether expenses are reimbursed, who provides tools/supplies, etc.) For example, if the worker can realize a profit or incur a loss, he/she may be an independent contractor.
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Relationship of the Parties: Are there written contracts or employee type benefits (i.e. pension plan, insurance, vacation pay, etc.)? Will the relationship continue and is the work performed a key aspect of the business? For example, if the worker receives benefits such as health insurance, pension, or paid leave, this indicates the worker is an employee.
If an employer can show reasonable basis for classifying a worker as an independent contractor according to the three categories above, he/she might be relieved from having to pay Social Security and Medicare taxes for that worker. The IRS can be reasonable if you give them a chance! For a more detailed explanation of the three categories, go to the IRS web site and search independent contractor.
