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  1. Home
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  3. Why It’s Important to Classify Employees vs. Independent Contractors

Why It’s Important to Classify Employees vs. Independent Contractors

Posted by Margaret Amsden on December 18, 2020

Margaret Amsden Margaret Amsden

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.

Contact Us

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.

Our team is always ready to help.

Please contact us for more information.

Margaret Amsden

Margaret Amsden

Shareholder, Private Client Services

Contact Margaret   |   Read Margaret's bio

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Why It’s Important to Classify Employees vs. Independent Contractors

Posted by Margaret Amsden on December 18, 2020

Margaret Amsden

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.

Contact Us

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.

Our team is always ready to help.

Please contact us for more information.

Margaret Amsden

Shareholder, Private Client Services

Contact Margaret   |   Read Margaret's bio

related news

Financial Management: 4 Key Technology Transformations

The accounting industry looks a lot different these days than it did 10 years ago. From shifts towards data-driven strategy to the implementation of new technological tools, the profession has…

Read full story

5 Financial Considerations for Architecture and Engineering Firms

Working with walls, light, shadow and the properties of a nearly endless array of building materials, architects and engineers create the spaces in which we live and work. Some are…

Read full story

How to Increase Tax Savings with a Roth IRA-Owned IC-DISC

Did You Know Combining these Strategies Can Help You Save Even More Tax Dollars? Many business owners may already be aware of the very popular tax saving strategies that exist…

Read full story

Family-Owned Businesses: Succession Planning

In this episode of The Sound of Automation podcast, Frank Lashier III, COO of Dominion Technologies Group, Inc. joins us to talk about the challenges of transitioning a business within a…

Read full story

Clayton & McKervey Announces Appointment as Key Global Partner for the Centuro Global Network

Media Contact: Denise Asker, dasker@claytonmckervey.com; 248.936.9488 Southfield, Mich.—April 5, 2021—Clayton & McKervey, a certified public accounting and business advisory firm helping growth-driven companies compete in the global marketplace, is pleased…

Read full story

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