How to Avoid Misclassification of Employees

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The consequences of misclassifying an employee as an independent contractor can be a costly mistake for a small business.  If you have no reasonable basis for classifying the employee you may be liable for the employment taxes for that worker (current and prior years without recourse to the worker).

Employers must withhold employment taxes for employees and issue a W-2 at the end of year.  The employer typically does not have to withhold employment taxes for independent contractors and must issue a 1099 at the end of the year to all workers paid more than $600.

To determine if someone is an employee or independent contractor under common law, the relationship between the worker and business needs to be reviewed.  The degree of control and independence should be considered.  The degree of control and independence falls into three areas:

• Behavioral – Instructions given to the worker.  A few examples include:

1. Who controls how the worker does the task? 
2. Who tells the work which tools or equipment to use?
3. What work is too be performed?

• Financial – A few examples include:

1. Does the worker have an investment in tools to perform the work?
2. Does the worker make their services available to others?
3. Can the worker realize a profit or loss?

• Type of Relationship – A few examples include:

1. Are there contracts describing the relationship?
2. Do you provide benefits to the worker?
3. Are the services performed by the worker a regular service of the company?

In some cases certain parts of a workers job can exhibit both employee and independent contractor characteristics.  The line can be blurry when determining which characteristics are more important than others.  For example, if you answered three questions that said, "employee" and three questions that said, "independent contractor" which prevails as the classification?  Never assume another business classified their workers correctly as some businesses classify their employees incorrect. 

Be sure to classify your workers correctly this mistake can be costly if your business was subject to an IRS audit.  If you are not sure seek advice from accountant, payroll provider, or complete the Form SS-8.  Once you complete Form SS-8 you can ask the IRS to make the determination for you.