On July 20, 2017, the Internal Revenue Service (IRS) issued a reminder for employers to accurately classify workers as employees or independent contractors.
The IRS stated it is important for employers to do this, as failing to do so correctly can lead to trust fund penalties. These can be measured not only against the employer but also against company management.
The main difference between an independent contractor and an employee for employers is that an employer must withhold income taxes and pay social security, Medicare taxes and unemployment tax on wages paid to employees, whereas independent contractors are instead subject to self-employment tax.
The IRS describes three categories to classify workers:
1. Behavioral control
A worker is an employee if the employer directly controls the work performed, even if the right is not exercised. These categories include:
- Instructions given: when and where to work, what tools to use, where to purchase supplies, etc.
- Level of instruction: more detailed instructions available for employees vs. independent contractors
- Evaluation: employees are evaluated by how the work is done, while independent contractors are evaluated by the result
- Training: on-going training about procedures and methods often means the worker is an employee rather than an independent contractor.
2. Financial control
A worker is an employee if the employer directly controls the financial aspects of their position. Here are a few examples:
- Investment: if the employer invests significant finances in the equipment the worker is using
- Method of payment: an employee is generally given an hourly, weekly, etc. wage. Independent contractors most often are paid by the job for a flat fee.
3. Relationship of the parties
Does the employer have an ongoing relationship with the worker? Here are some categories that define relationships:
- Benefits: Employees receive benefits such as vacation time, paid sick leave, etc. Independent contractors generally do not receive these.
- Permanency of the relationship: Employees and employers usually have an expectation that the relationship will continue indefinitely while independent contractors and employers have an understanding that the contractor will be there for a certain period.
With these three guidelines, the IRS hopes to clear up any confusion about classifying employees. To read more about these guidelines, refer to the IRS 20-factor test.