4 minute read
Entrepreneur’n Moore
Do you know the difference between an employee and an independent contractor?
Advertisement
The ruckus over employee classification comes down to taxes.
If you "misclassify" a worker and do not correctly withhold or pay the required withholding and benefits, the IRS may flag your business and come after any money owed.
Suppose a staff member is classified as an employee. In that case, you need to withhold, deposit, report, pay employment taxes, withhold and pay Social Security and Medicare taxes, and pay unemployment tax on wages paid. The IRS also requires that you file special paperwork for employees.
If a worker is classified as an independent contractor, you are not required to do as much legwork. Independent contractors arrange and pay their own income tax quarterly, are not given any benefits, and are not eligible for things like unemployment insurance.
So, what is the difference between an employee and an independent contractor?
Employees get paid a regular wage, receive employee benefits, have taxes withheld from those wages, and have their work and schedule dictated by the employer. Full-time employees are also offered more protection: severance, workers compensation, anti-discrimination protection, etc. Their employees must pay payroll taxes on their wages.
Independent contractors are the reverse. They tend to get paid for projects, worry about their own taxes, and work when and where they want. For tax purposes, the IRS considers them self-employed, which means they must pay self-employment tax.
The main difference boils down to the degree of control: if the employer is dictating all the terms and doing so consistently over time, the person is probably an employee.
The evidence tends to fall into three main categories: behavioral control, financial control, and relationship control.
Behavioral control.
The behavioral control test focuses on whether the company controls or has the right to control what the worker does and how the job is done. Behavioral control factors include types of instruction given, degree of instruction, evaluation systems, and training. Financial control.
The financial control test looks at who controls the economics of the worker's job. Being able to work for multiple employers and providing one's tools may indicate Independent Contractor status. Factors pointing to employee status are eligibility for reimbursement of travel costs and payment based on hours worked. The financial control factors are: • A significant investment. • Unreimbursed expenses. • Opportunity for profit or loss. • Availability of the services to the market. • Payment method.
Relationship control.
The relationship control test examines how the parties perceive each other. Providing paid vacation and retirement benefits indicates a worker is an employee, as does hiring to provide services indefinitely rather than for a specific time. Written language stating the worker is an Independent Contractor is not determinative. The factors include: • The existence of written contracts. • The offering of employee benefits. • Permanency of the relationship. • Services provided as a vital business activity.
The key is to look at the entire relationship, consider the degree or extent of the right to direct and control, and document each of the factors used in coming up with the determination.
The prior administration's rules regarding Independent Contractor or Employee determination were recently overturned, and the final rule under the new administration became effective May 2021, under the Fair Labor Standards Act (FLSA).
In the final rule, the Department: 1. Reaffirms an "economic reality" test to determine whether an individual is in business for him or herself (independent contractor) or is economically dependent on a potential employer for work (FLSA employee).
2. Identifies and explains two "core factors" that are most probative to the question of whether a worker is economically dependent on someone else's business or is in business for him or herself: • The nature and degree of control over the work. • The worker's opportunity for profit or loss is based on initiative and/or investment.
3. Identifies three other factors that may serve as additional guideposts in the analysis, particularly when the two core factors do not point to the same classification. The factors are: • The amount of skill required for the work. • The degree of permanence of the working relationship between the worker and the potential employer. • Whether the work is part of an integrated unit of production.
4. The actual practice of the worker and the potential employer is more relevant than what may be contractually or theoretically possible.
You can download the 15-A (2021) publication from the irs.gov website for further detail regarding the criteria to determine whether an individual is an employee or an Independent contractor.
In summary, there are high risks, liability, interest, and penalties for incorrectly classifying an employee as an Independent Contractor. Please consider reviewing the IRS and Fair Labor Standards Act rules and consult your CPA or employment law attorney to ensure the correct classification and minimize future exposure.
Henry Dumas, Business Coach
ICF Credentialed Coach – MCC linkedin.com/in/henrydumas Moore Norman Technology Center 405-801-3540 • mntc.edu
