An Important Reminder for Your Year-End Financial Check-Up
Worker misclassification has been a long-standing issue because of the difficulty in distinguishing employees from independent contractors. An “employee” must be distinguished from an “independent contractor,” because an employer does not generally have employment tax obligations or fringe benefit obligations with respect to independent contractors. When employers inadvertently misclassify workers, the employer is liable for the cost of back taxes, interest, and penalties associated with correcting the issue. The employer could also be subject to penalties for discrimination related to various benefit plans. Therefore, it is important to make sure employees and independent contractors are correctly classified.
For many years, the Internal Revenue Service (“IRS”) relied on a 20-factor test to determine whether individuals were employees or independent contractors. The IRS has shifted its analysis from the 20-factor test and moved to a three-part behavioral analysis. Clayton & McKervey has outlined the three factors below to help with classifying employees vs. independent contractors.
Three Factors to Consider When Determining Employees vs. Independent Contractors
1. Behavioral Control: Does the employer control (or have the right to control) what the worker does, and how the worker completes his/her job through instructions, training, or other means?
- If you receive extensive instructions on how work is to be done (how, when, or where to work; what tools or equipment to use; what assistant to hire to help with the work; where to purchase supplies and services), this suggests you are an employee.
2. Financial Control: Does the employer control the business aspects of the worker’s job? This includes significant investment, expenses, and opportunity of profit or loss.
- If you have a significant investment in your work, you may be an independent contractor.
- If you are not reimbursed for some or all business expenses, then you may be an independent contractor.
- If you can realize a profit or incur a loss, this suggests you are in business for yourself and you may be an independent contractor.
3. Relationship of the Parties: Does the worker receive employee-type benefits? Will the relationship continue after the work is finished? Is the work a key aspect of the employer’s business?
- If you receive benefits, such as insurance, pension, or paid leave, this is an indication you may be an employee.
- If you have a written contract both you and the business agreed on for the products/service produced, you may be an independent contractor.
Keep in mind that starting in 2020, the 1099 reporting of nonemployee compensation for independent contractors is now to be reported on the new Form 1099-NEC.
It is important to consider all of the facts when classifying independent contractors vs. employees, as no single fact will provide the answer. If you need help distinguishing between employees vs. independent contractors and reviewing the potential tax or fringe benefit obligations, please call us at 248.208.8860 or click here to contact us. We look forward to speaking with you soon.