Whether it is an established firm or a budding enterprise looking to bring on additional help, a business needs to consider how its workers will be classified.

Worker classification is important when determining if it is the duty of an employer to withhold and pay Social Security, Medicare, unemployment tax, and state taxes from wages paid to an employee. For independent contractors, their earnings are subjected to self-employment tax.

An individual is termed an independent contractor if they are in a trade, business or profession in which they offer their services to the general public. Small businesses should analyze the degree of control given to a worker because that determines if they are an employee or independent contractor. However, this can vary based on individual facts and circumstances.

A Simple Guide to Worker Classification

To determine whether a worker is an employee or independent contractor, consider who has control in following categories; Financial Control, Behavioral Control, and Relationship.

FINANCIAL CONTROL

Financial control concerns which party maintains the right to direct or control the financial aspects of the worker’s job? Consider the following:

Has the worker invested significantly in the equipment they use to execute their job?
Employees are usually provided with a workspace and the tools to complete the tasks they are given. Independent contractors are responsible for bringing their own tools and preparing their workspace.

Does the worker accumulate unreimbursed expenses related to the work?
Independent contractors are responsible for maintaining records of any expenses related to the work to deduct at tax time. By contrast, employees are typically reimbursed by their employer for expenses they incur during the course of work.

Is there an opportunity for profit or loss?
If the project is not as profitable as originally thought, the independent contractor is the one that bears the brunt. An employee does not have to be concerned with how profitable their tasks are.

Method of payment
An employee is entitled to regular wage amount for a specific period of working which is supplemented by a commission. However, independent contractors are frequently paid a flat rate.

Who is responsible for the services?
Independent contractors can seek out business opportunities in the market which they can accept or reject. Employees are not always allowed the same degree of autonomy.

BEHAVIORAL CONTROL

If a business has the right to control and direct the work done by a worker, that worker is an employee. This applies even when that right is not exercised. In terms of behavioral control, the following will aid in determining where a worker stands:

Type of Instructions given
If the business is responsible for dictating the hours and location or the work, tools to use, and where to purchase supplies, then this can suggest the worker is an employee. An independent contractor is able to work when and how they see fit.

Degree of Instruction
Detailed instruction reflects a high level of control, and this can indicate that the worker is an employee. Scant instructions may be an indication that a worker is an independent contractor.

Evaluation System
The evaluation system put in place by a business to measure the work done can indicate a whether the worker is an employee or a contractor.

Training a Worker vs on the Job Execution
Offering training to a worker about methods and procedures is a strong indication that the worker is an employee since independent contractors use their own methods to execute tasks given to them.

RELATIONSHIP

How a worker relates and interacts with business says a lot the status of that worker. Here are several indicators you can use to know whether a worker is an employee or independent contractor.

Check the written Contracts
This describes the nature of the job and the relationship the two parties have. Although not sufficient evidence, you can use it to back your claims of whether a worker is an employee or a contractor.

Benefits
When a worker is entitled to a pension plan, insurance, sick pay, vacation pay, they are considered an employee of the business. These benefits and many more are generally not extended to contractors.

Duration of the Relationship
If the relationship period is not defined, this can indicate an employer-employee relationship. However, a relationship that is definite or restricted to a specific project may indicate an independent contractor.

Type of Services Offered
Workers carry out activities that are vital to the business and sometimes can be repetitive or seasonal in nature. A contractor is typically only needed for specific projects or tasks.

Consequences of Misclassifying an Employee

If you classify your employee as an independent contractor without logical basis, then you, as an employer, will be liable for employment taxes. However, if you raise reasonable grounds as to why you didn’t treat a worker as an employee, you can avoid paying employment taxes. Read more on this in Publication 1976, Section 530 Employment Tax Relief Requirements.

In addition, the Voluntary Classification Settlement Program offers options to certain eligible business to reclassify their workers as employees in a way that they receive partial relief from employment taxes.

Employers can use Form SS-8, offered by the IRS, to determine the status of their workers. Also, IRS Publication 15-A can serve as an excellent resource for further research.

Workers can use Form 8919, if they feel they were improperly classified as independent contractors, to claim their employee’s share of Medicare taxes and Social Security due on their compensation.

Either way be sure to keep records and clarify the position as much as possible upfront. Happy Hiring!