Have you ever wondered if those “people” working for you are actually your Employees or Independent Contractors? The IRS classifies an Independent Contractor as someone who controls the manner and means by which contracted services, products, or results are achieved. The more control the company itself exercises over these individuals, such as how, when, where, and by whom the work is performed, designates if workers are more than likely classified as employees.
The IRS has determined the 20 Factor Test to aid in this classification. A worker does not have to meet all 20 items of the criteria to qualify, and no single factor is decisive in determining their working status. If you are still unsure of what to classify a worker as, a request can be sent to the IRS by filing form SS-8 “Determination of Employee Work Status for Purposes of Federal Employment Taxes and Income Tax Withholding.” As a reference, it has been noted by tax specialists that the IRS usually classifies workers as employees whenever their status is not clear cut.
20 Factors Test Criteria
|1. Level of Instruction
2. Amount of Training
3. Degree of Business Integration
4. Extent of Personal Services
5. Control of Assistants
6. Continuity of Relationship
7. Flexibility of Schedule
8. Demands for Full-Time Work
9. Need for On-Site Services
10. Sequence of Work
|11. Requirements for Reports
12. Method of Payment
13. Payment of Business or Travel Expenses
14. Provision of Tools and Materials
15. Investment in Facilities
16. Realization of Profit or Loss
17. Work for Multiple Companies
18. Availability to Public
19. Control Over Discharge
20. Right of Termination
Below is an easier way to look and answer these criteria options for your “employees.”
Behavioral Control: Employers tell employees (but NOT independent contractors)
- When and where to work
- What tools or equipment to use
- Who to hire to assist with the work
- Where to purchase supplies and equipment
- What work must be performed by a specified individual
- How to do the job (order of sequence to follow, detailed instructions)
- Evaluating how the work was done, not just what was done
- Employers don’t normally train independent contractors
- Significant Investment – normally don’t have to put up capital to be employees
- Unreimbursed Expenses – independent contractors are more likely to have unreimbursed expenses
- Opportunity for profit or loss – possibility of incurring a loss indicates an independent contractor
- Services available to the market – independent contractors advertise and seek out new business
- Method of payment – employees get an hourly wage or a salary; contractors are normally a flat fee that was discussed or signed in a contract (not including the salary or hourly rate that an employee would be paid)
How does the type of relation affect status: “if they’re seeing other people, they are independent contractors.”
- Written contracts between business and contractor
- Benefits – contractors don’t receive benefits from customers, but that doesn’t necessarily mean they are independent contractors
- Permanency – if you believe the relationship will continue indefinitely, you are most likely an employee
- Services provided are key to the business – key services generally require more behavioral control
As an employer with employees, you are responsible for withholding and remitting income tax, social security and Medicare taxes from all wages paid to employees. You are also required to pay the employer portion of social security, Medicare, and FUTA (federal unemployment) taxes on wages paid to your employees. Employers must provide W-2’s, Wage and Tax Statements, showing gross income and the amount of taxes withheld from employee pay annually.
When hiring independent contractors, employers must complete, annually, the IRS Form 1099-NEC and, the supporting IRS Form 1096. To ensure your 1099’s are accurate, businesses should be maintaining completed IRS Form W-9s on file for all independent contractors, in addition to W-9s for applicable vendors. Using independent contractors puts the tax burden on the individual as they would become responsible for paying their own income and self-employment taxes.
What is the Punishment for Being Wrong?
There is a failure to pay penalty of 0.5% per month that is capped at 25%. Possible criminal penalties up to $1,000 per misclassified worker and up to 1 year in prison. The person responsible can be held personally liable for uncollected taxes. There is a penalty of 12.21% of improperly classified wages plus any interest. If fraud is suspected this is bumped up to 35.3%. A charge of $50 for each W-2 that didn’t get filed.
How do People Get Caught?
Someone files for unemployment thinking they were an employee when they weren’t. Someone gets injured and files for workers comp and is not being considered an employee, or someone calls and reports the error or incidents to the IRS themselves.
When in doubt, always ask and find out before assuming any kind of status.
If you would like to talk to one of our professionals in our Entrepreneurial Support & Client Accounting Segment on this topic or any other business related topic, please do not hesitate to contact us.