Making the right classification for workers performing services has become more important than ever for a business. Let’s look at two different categories:
Employee status imposes significant tax and legal obligations on an employer. The employer is responsible to withhold and remit the employee’s share of Social Security & Medicare tax, federal income tax and any state income tax. The company must also pay the “employer’s portion” of Social Security tax (6.2% on the first $110,100 of wages for 2012) and Medicare tax (1.45% on all wages), as well as federal and state unemployment taxes. Companies are also exposed to a host of costs and regulations affecting employees, for example: benefits, minimum wages, overtime pay, discrimination and worker’s compensation laws.
Independent contractor status means the person performing services will receive full, 100% pay with no payroll tax deductions. At the end of the year the worker will receive a Form 1099 if total payments exceed $600. The independent contractor is responsible for calculating their net income, and paying all required income and payroll taxes. The business is not obligated to the independent contractor for any of the items mentioned above for an employee.
Employers have obvious monetary incentives to treat workers as independent contractors. However in an effort to protect employee rights, the IRS, Department of Labor and other federal and state government agencies are looking hard at the relationship between business and workers. The IRS recently issued Publication 1779 to clarify worker classifications. Evidence of control and independence seem to be the key factors in determining whether a person is deemed an employee or independent contractor. According to the IRS, facts fall into three main categories:
1. Behavioral Control – A worker is an employee when the employer has the right to direct and control the work. Examples of behavior control are:
- Extensive instructions about work being performed, such as how, when or where to do the job.
- Training provided by the employer about required procedures and methods to do the work in a certain way.
2. Financial Control – Factors indicating an independent contractor relationship include:
- If you have a “significant investment” in the work, you may be an independent contractor. There is no exact dollar test to this guideline.
- Workers who are not reimbursed for some or all business expenses for the job may be an independent contractor. Again, there is no dollar amount given.
- Your opportunity for Profit or Loss for performing the job indicates you may be an independent contractor.
3. Relationship of the Parties – These facts show how the business and worker recognize their relationship:
- Are you receiving benefits such as sick days, vacation days or insurance? This suggests you are an employee.
- Is there a written contract between you and the business? Provisions such as length of job and worker’s right to hire assistants and control how the job will be done lend credibility to being an independent contractor.
Although Publication 1779 attempts to set standards, there is still wide room for error when it comes to structuring an independent contractor relationship. Gary Kaplan can help you determine the classifications described above.
