How to Avoid Misclassifying an Employee as an Independent Contractor

Independent contractor vs employee which is better for the worker, the business or the IRS?

Many businesses struggle with understanding the difference between independent contractors vs employees. Simply put employees are issued a W2 at year-end while independent contractors are issued a 1099-Misc. Since vocabulary is always an issue in business, independent contractors are called 1099 subcontractors or just 1099 contractors.

Most small business owners would prefer to have everyone classified as an independent contractor to avoid all the friction that the government places on business with employers.

Businesses that use independent contractors vs employees are not required to provide independent contractors benefits, withhold federal, state, and FICA taxes, match the employee’s FICA contributions, or pay for workers’ compensation, or unemployment insurance. Therefore having independent contractors vs employees is cheaper and has fewer hassles for the business.

Moreover, the 2017 Tax Act stipulates that individuals who are independent contractors can qualify for a 20 percent tax deduction on their 1099 income as long as they are engaged in a trade or business and make less than $157,500 as an individual or $315,000 in a business owned by a couple filing jointly.

Since the new tax law potentially rewards independent contractors, the IRS expects many employees to request their status to be changed from a W2 employee to a 1099 subcontractor. Moreover, businesses would be eager to reclassify employees to an independent contractor status to save on insurance coverage as well as the FICA match.

However, the IRS would rather that businesses have employees so that a single employer is responsible for all the withholdings as opposed to multiple independent contractors.

Related Post: Why Being an Employee is Just too Risky

Contractor or Employee – The IRS 20 Question Test

Keeping in mind that the IRS considers a person to be an employee unless proved otherwise, the IRS has developed a 20-question test to determine if a person should be classified as an employee or an independent contractor. “Yes” answers most likely indicate that if challenged, the person will be classified as an employee and not as an independent contractor by the IRS.

1. Is the worker required to comply with the employer’s instructions about when, where, and how to work?

2. Is training required? Does the worker receive training from or at the direction of the employer, includes attending meetings and working with experienced employees?

3. Are the worker’s services integrated with the activities of the company? Does the success of the employer’s business significantly depend upon the performance of services that the worker provides?

4. Is the worker required to perform the work personally?

5. Does the worker have the ability to hire, supervise and pay assistants for the employer?

6. Does the worker have a continuing relationship with the employer?

7. Is the worker required to follow set hours of work?

8. Does the worker work full-time for the employer?

9. Does the worker perform work on the employer’s premises and use the company’s office equipment?

10. Does the worker perform work in a sequence set by the employer? Does the worker follow a set schedule?

11. Does the worker submit regular written or oral reports to the employer?

12. How does the worker receive payments? Are there payments of regular amounts at set intervals?

13. Does the worker receive payment for business and travel expenses?

14. Does the worker rely on the employer for tools and materials?

15. Has the worker made an investment in the facilities or equipment used to perform services?

16. Is the payment made to the worker on a fixed basis regardless of profitability or loss?

17. Does the worker only work for one employer at a time?

18. Are the services offered to the employer unavailable to the general public?

19. Can the worker be fired by the employer?

20. Can the worker quit work at any time without liability?

Penalty for Misclassifying Employee as an Independent Contractor

Misclassifying an employee as an independent contractor can prove to be a very expensive mistake for an employer. The employer may not only have to pay additional wages but fines and fees. Then there is the matter of back workers’ compensation and unemployment taxes.

Worker’s Compensation:

An employee who is hurt on the job can receive benefits under workers’ compensation as an employee. However, independent contractors are not required to have worker’s compensation. An independent contractor who is hurt on the job may try to sue the business claiming that they were treated as an employee to received workers’ compensation benefits from the business.

Unemployment:

Employees benefit from unemployment compensation insurance. Independent contractors who are terminated may try to sue the business claiming that they were treated as an employee to claim the benefits they would have received if the employer had treated them as an employee.

Disgruntled Independent Contractor & Form SS-8

As we said earlier, the IRS is normally biased towards employee status. If as a business owner, you have any questions pertaining to employee vs independent contractor classification you can file a Form SS-8 to get clarification from the IRS.

Oftentimes a disgruntled independent contractor will file a Form SS-8 out of spite for the business claiming employee status. In these cases, the IRS will often approach the business and ask that it payback employment taxes, penalties, and interest, while refunding employment taxes paid by the independent contractor. Therefore, when an independent contractor files a Form SS-8 with the IRS, they can potentially be refunded quite a bit of money while punishing the business.

Have you misclassified employees as independent contractors?