One of the most basic questions about the employment relationship is whether a worker is an employee or an independent contractor. As with so many employment law issues, the answer is, "It depends”.
Employee status triggers employer obligations under various federal and state laws that do not apply to independent contractors, and the responsibility for classifying a worker is the responsibility of the employer. When determining if a worker should be classified as an Employee or an Independent Contractor there are many variables. HPC can offer a wide variety of information to help clients make the right classification if necessary.
Differences between Independent Contractor and Employee
The IRS has three general criteria to distinguish the difference between an Independent Contractor and an Employee:
- Behavioral Control - If the worker does not have the right to control when and where to do the work, what tools to use, and if there are detailed instructions on what work needs to be performed by the individual, then they are most likely an Employee. If the worker has control over their own working hours and has the ability to work how they would like to, with little to no training, than the classification would lean heavily towards Independent Contractor.
- Financial Control - If a worker is guaranteed a regular wage for a period of time, this usually means the worker is an Employee. If the worker is paid a flat fee per job and they have a possibility of incurring a loss if their expenses exceed their income, they are usually considered an Independent Contractor.
- Type of Relationship - If a worker is hired with expectations of an indefinite relationship and provides services that are necessary for the business to operate, this usually means the worker is an Employee. If the worker does not have benefits like paid vacation or if they are hired for a certain amount of time as stated on a contract, they will usually be considered an Independent Contractor.
Common situations and considerations:
- Organization “incorrectly” decides to hire an independent contractor to avoid employer tax liability.
While this may seem obvious, organizations can’t use the classification of independent contractor to avoid tax, equal employment opportunity, and other applicable employee legal requirements.
- Company hires an independent contractor and then “incorrectly” dictates the work hours and how the job is done.
If the employer will control how the work is performed, that would lean heavily towards Employee status. If the employer wants full control then hiring an employee would be the safer course of action. If the organization is concerned only about the final product and does not need to dictate how the worker accomplishes the tasks of the project or role, then an Independent Contractor may be the preferred approach.
- An employer hires an independent contractor that begins working full-time hours over an extended period of time.
This is a case that has gotten employers in trouble time and time again. You have a person that is fully entrenched in all the aspects of your business. The line becomes blurry when they are working full-time hours, meeting with other employees, working inside or outside the office, beginning to ask about employee perks and benefits and starting to blend in as an employee. If you have any independent contractors that look like this, it’s time to re-evaluate.
- An organization “incorrectly” hires an employee for a specific project, knowing additional work will not likely be available.
If the staffing need relates to a specific project with no likelihood of continued employment, using an Independent Contractor as project manager would avoid the problem of having to layoff an employee when the project is done. This type of role would definitely weigh heavily in favor of an Independent Contractor. Part-time workers and interns can also fall under Employee classification and need to be reviewed carefully.
- Hiring for roles that require a high level of independent judgment, specialized knowledge, training or experience may lean towards an Independent Contractor.
When the job requires exercising independent judgment, an Independent Contractor may be a sound choice. The organization might also choose an outside contractor to manage complex projects, such as transitions during and after a merger or an acquisition. Organizations routinely engage outside professionals such as information technology professionals, accountants and attorneys to manage specific projects and tasks within an organization.
There can be multiple fines, penalties and other ramifications for misclassifying workers
Classifying a worker as an Independent Contractor should always be an informed and bona fide business decision, not a way to avoid the employer's obligations to employees. Independent Contractor arrangements have drawn increasing scrutiny and significance with the proliferation of workplace laws covering employees and the growth of the contingent workforce. Misclassification of an individual as an Independent Contractor can give rise to a variety of liabilities.
HPC just completed two 1099 audits with clients who had not made the right classification choices prior to joining, and ended up having to pay back taxes and penalties. Employment rules and regulations may vary by state due to individual state requirements.
How can HPC Assist?
There can be tax ramifications, fines and penalties from the IRS, Worker’s Compensation pay backs, to name a few of the various potential liabilities. The IRS offers an opportunity for the employer to file Form SS-8, Determination of Worker Status for Purposes of Federal Employment Taxes and Income Tax Withholding, with the information regarding the role. This form will be sent to the IRS who will assist in making the formal determination on the worker’s status and can be a time consuming process, usually six months on average. In the meantime, HPC can help to advise you on the reporting requirements for employees versus contractors.
HPC also implements the best tools and practices to help ensure seamless timely filing associated with year end 1099’s for contractors by end of January, as well as payroll automation, including associated payroll tax payments and year end W2 filings when managing employees. These forms are requirements not only for payroll and federal compliance, but also need to be reported accurately on your year end income tax return, which HPC will also file on your behalf.
Click on the link below to Schedule a Free Consultation to see how HPC can assist you in streamlining paying your people while also keeping you in compliance and properly classifying your workforce.
Because each situation is unique, any recommendations are not intended for your particular situation. As with all advice, the key is to discuss your individual strategy with your advisor before taking any action.