From the IRS’ perspective, all workers fall into one of these two groups. Categorizing workers this way helps employers determine from which workers they must withhold a portion of wages to pay income, Social Security, Medicare and unemployment taxes. Withholding is required for employees but not independent contractors.
Making the wrong worker classification determinations can be costly. If the IRS determines that you have misclassified an employee as an independent contractor, you could be liable for paying the worker’s employment back taxes you should have been paying all along, along with tax penalties.
IRS Guidance Helps in Making Determination Decisions
So how do you determine whether your workers are employees or independent contractors? Fortunately, the IRS provides specific guidance to help you make this determination. There are three main aspects of the employer-worker relationship that the IRS considers in making the employee vs. independent contractor determination:
- Behavioral control — This has to do with the level of control your business has over the jobs that your workers perform and how they go about performing them.
- Financial control — This has to do with the level of control your business exerts over the business aspects of jobs. such as how payment is made, whether or not expenses incurred by workers are reimbursed, and who provides tools needed to perform the job (such as a computer and desk).
- Type of relationship — This has to do with whether the nature of the relationship between your business and the worker is ongoing or temporary, as well as whether the work performed is considered to be a key aspect of the business. For example, is there a written contract between your business and the worker, and do you provide the worker with benefits like health insurance and paid vacation?
The IRS encourages businesses to give equal weight to all three of these aspects when classifying workers as employees or independent contractors. No single factor is more important than another and different factors may be more relevant than others in certain situations.
Also, some factors might indicate that a worker is an employee while others indicate that the same worker is an independent contractor — so the determination isn’t always cut and dried. The IRS encourages businesses to view the entire employer-worker relationship, instead of just one aspect of the relationship, in order to make the correct determination, as well as keep thorough documentation of all relevant factors.
The more control exerted by the employer, the more likely it is that a worker should be considered an employee
The IRS 20-Factor Test
The IRS has devised a 20-factor test to help businesses make the right worker classification determinations. Each of these factors is intended to help determine who exerts the most control over how work is performed — the employer or the worker?
The more control exerted by the employer, the more likely it is that a worker should be considered an employee. Conversely, the more control exerted by the worker, the more likely it is that he or she should be considered an independent contractor. Among the factors included in the IRS 20-factor test are the following:
- Level of instruction — Does your business or the worker dictate when, where and how work is performed? If it’s your business, this indicates that the worker is possibly an employee.
- Amount of training — Do you request that workers undergo company-provided training? If so, this indicates that the worker is possibly an employee.
- Degree of business integration — Is the work performed closely integrated into business operations? If so, this indicates that the worker is possibly an employee.
- Flexibility of schedule and demands for full-time work — Does your business dictate the worker’s hours and days of work or demand that he or she work full-time? If so, this indicates that the worker is possibly an employee.
- Method of payment and payment of expenses — Is payment made on an hourly, weekly or monthly schedule, and are work-related (including travel) expenses reimbursed to the worker by your business? If so, this indicates that the worker is possibly an employee.
- Investment in facilities — Does your business provide the work facilities where the worker performs his or her job? If so, this indicates that the worker is possibly an employee.
- Control over discharge and right of termination — Does your company maintain the unilateral right to discharge the worker or terminate the work without liability? If so, this indicates that the worker is possibly an employee.
Click here to read the full IRS 20-factor test.
Getting an Official IRS Determination
If you’re still unsure about how to classify a worker after you’ve considered all of these factors, you can receive an official IRS determination by filing IRS Form SS-8, Determination of Worker Status for Purposes of Federal Employment Taxes and Income Tax Withholding. The IRS will then make an official determination for you.
Note, however, that receiving this determination can take at least six months, so you’ll need to plan ahead and consider consulting a tax attorney or accountant. Also, you could lose certain protections against misclassification liability by filing this form. If you regularly hire similar types of workers to perform certain tasks, you could file Form SS-8 once for each job and then use the IRS determination for all hires that you make in the future.
In addition to IRS guidelines, states also have their own guidelines for determining workers’ classification status with regard to workers’ compensation and unemployment insurance laws. Most states use an economic realities test that makes it more difficult to classify workers as independent contractors. Click here for state-specific information about worker classifications.
Proper Determinations Are Crucial
It’s crucial to make the right employee vs. independent contractor determinations for your workers in order to avoid potential back taxes and penalties. Visit the IRS website for more details.
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