Much of today’s workforce is part of a growing gig economy. According to a study by Intuit Inc., by 2020 40% of the American labor market will be considered independent contractors.
Contract employment can have many perks such as safeguarding a business against the high cost of benefits, office space and taxes. Becoming an independent contractor is also attractive to the worker due to flexibility over their schedule and the duties they will perform.
Today’s gig economy, however, doesn’t come without repercussions. Many business owners fail to recognize the effects of classifying an individual as an employee versus an independent contractor. For example, if you have misclassified the individual, you risk exposing yourself to significant tax liabilities.
As defined by the IRS, an employee is anyone who performs services as directed and controlled by the employer. Classifying workers as employees requires that a company withholds applicable federal, state, and local income taxes, pay Social Security, Medicare taxes, state unemployment insurance tax, and pay any workers compensation fees. Employee status also requires filing a number of returns during the year with various taxing authorities and providing W-2’s to all employees by January 31. Employees may also have rights to benefits such as vacation, holidays, health insurance or retirement plans.
In working with business owners over the years, we have uncovered many misconceptions around worker classifications. The most common include:
- the worker wants to be treated as an independent contractor;
- the organization has a signed contract with a service provider;
- the worker does assignments sporadically, inconsistently or is on-call to the organization; and
- the worker is virtual or remote.
The IRS states that taking assignments from many companies does not necessarily justify an independent contractor status. Simply put, the determination of whether a worker is an employee or an independent contractor rests primarily upon the extent that the employer has to direct and control the individual regarding what and how to accomplish an activity. In other words; independent contractors determine for themselves how to best complete a given assignment while employers control how an employee performs a service.
To help business owners make this determination, the IRS has developed tests that will determine the extent and direction of control present in any employer/employee/independent contractor situation. The degree of importance of each factor varies depending on the occupation and the facts of the particular case.
IRS Control Test
Behavioral Control. When the business can direct and control the work performed by the worker, the worker status is determined to be Employee.
- Is the individual required to comply with instructions about when, where, and how to perform the work? Prescribing detailed instructions may indicate a worker is an employee. Conversely, less detailed instructions reflect less control, which may indicate the worker is more likely to be an independent contractor.
- Individuals who are trained to perform a job using a particular method are usually considered employees. Training is instruction provided by an experienced worker that requires the trainee to attend meetings or correspond with the trainer in other methods. Independent contractors bring their skills to your enterprise.
- Evaluating the details of how the work is done points to an employee while evaluating only the result can point to either an independent contractor or an employee.
Financial Control. If the business can direct or control the financial and business aspects of the worker’s job, it may suggest employee status. When a worker has a significant investment in his or her work facilities, this implies an independent contractor status.
- An employer generally pays expenses, which means it has a right to regulate and direct business activities thereby suggesting employee status.
- Independent contractors realize a profit or incur a loss. The risk of loss may be the result of investments in equipment or due to other expenses.
- Generally, you will not see employees market their services to the public on a regular basis.
- Paying your service provider by the hour, week or month suggests an employee status while paying an agreed-upon lump sum for a job suggests independent contractor status. In some situations, employers may also implement a straight commission basis of compensation without adversely affecting a worker’s status as an independent contractor.
Relationship. The type of relationship is dependent upon how the worker and business perceive their interaction with one another.
- Is there a written contract which describes the relationship the parties intend to create? Keep in mind, a contract stating the worker is an employee, or an independent contractor is not enough to determine the worker’s status.
- Businesses often provide employees with benefits such as insurance, pension plan, vacation pay or sick pay. These benefits are rarely offered to independent contractors.
- An employer-employee relationship is evident if the expectation is that the relationship will continue indefinitely instead of just for a specific project or defined period.
- Are the services provided considered a key activity of the business? If the worker is a vital component of the regular business of the company, it suggests employee status.
We work with many companies trying to identify whether their workers are independent contractors or employees. We would be happy to work with you in making these determinations. Call us today.
Treasury Circular 230 Disclosure
Unless expressly stated otherwise, any federal tax advice contained in this communication is not intended or written to be used, and cannot be used or relied upon, for the purpose of avoiding penalties under the Internal Revenue Code, or for promoting, marketing, or recommending any transaction or matter addressed herein.