The IRS recently reminded business owners of the importance of properly classifying its workers as employees or independent contractors.
Businesses often prefer to characterize their workers as independent contractors rather than as employees, since independent contractors are responsible for their own taxes, including FICA, and are not subject to many of the laws protecting employees, such as wage and hour laws.
If, however, you treat someone as an independent contractor and that person is recharacterized as an employee by a government agency, significant penalties may be imposed.
Further, those who believe they have been misclassified as independent contractors are increasingly filing lawsuits against their employers.
Several factors are considered when determining whether a worker is an employee or an independent contractor. These factors vary from state to state and may also differ depending on the law involved, that is, the purpose for which the worker is characterized, e.g., for purposes of tax or workers compensation.
The test used by the IRS looks at the following three factors:
• Whether the business controls or has the right to control what the worker does and how the worker does the job;
• Whether the business directs or controls the financial and business aspects of the worker’s job; and
• What is the relationship between the parties, e.g., are there employee-type benefits such as health insurance and vacation pay and is the work performed a key aspect of the business?
Generally speaking, if a person is under the direction and control of the employer, it is more likely that the person will be characterized as an employee. If a person performs the task for one employer rather than for many, this also strengthens the employment characterization.
On the other hand, if the individual performs similar tasks for several different employers and functions independently, it is more probable that the individual will be characterized as an independent contractor.
When the employer provides the tools, equipment and a place to work, it is more likely that the person performing the task will be characterized as an employee, but if the individual provides his or her own tools, equipment and supplies, the argument that the worker is an independent contractor is reinforced.
The place where the work is performed, whether the person has his or her own business license, as well as other relevant factors, may also be considered when determining a worker’s status.
To strengthen the argument that a worker is independent, you should have a written contract requiring the worker to furnish all tools, materials and equipment necessary to perform the work, to obtain all necessary business registrations, permits and licenses, and to be responsible for hiring, paying, supervising and firing any employees working for that person, though statements in the contract are by no means decisive.
When assigning the work, you should be sure to allow the worker as much flexibility as possible with respect to how the work will be done; that is, your company’s main concern should be the finished product.
If you think you might have been misclassifying your workers, you may be interested in the IRS’s Voluntary Classification Settlement Program (VCSP), which allows businesses to reclassify their workers as employees for future tax periods for employment tax purposes with partial relief from federal employment taxes for eligible taxpayers that agree to prospectively treat their workers (or a class or group of workers) as employees.
Whether you are an employee or an employer, please feel free to contact us if you have any questions about worker classification or any other employment-law issues.
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For more information about employment law, see Employment Law (in Plain English)®, co-authored by members of this law firm. The book is available through Skyhorse Publishing, Amazon, Barnes & Noble, Powell’s Books, and Bookshop (an online bookstore that allows you to support your favorite independently owned bookstore).
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