It is critical for small businesses to appropriately classify a worker's employment status for tax reporting purposes. An employer's tax liability is determined by the worker's employment status. When a worker is an employee, employers must pay state and federal unemployment tax, social security tax and workers compensation/disability premiums to a State Insurance Fund. When a worker is an independent contractor, the hiring party is not required to make any of these payments. Should employers incorrectly define a worker as an independent contractor, they may find themselves liable for past taxes including FICA and federal unemployment tax and any associated penalties and interest.
The IRS and many states have adopted common law principles to define an independent contractor. These rules include:
Behavioral Control: This category is broken down into the subcategories of instruction and training to show whether the business owner has the right to direct and control the contractor's actions through direct instructions or specific training. If the company instructs the contractor on such things as when, where, how, and in what order the work will be performed, who will assist with the work, and who will perform specific tasks, and/or offer any training or instruction in the performance of the job, then the contractor can be considered an employee.
Financial Control: In this category, the IRS looks at how much control the company or management has over the business aspects of the contractor's job. Basically, if the contractor has expenses not reimbursed by the company, and makes investments of his or her own money, then the contractor is operating more like an independent contractor. However, if the company controls advertising the contractor's service exclusively, and purchases or reimburses the contractor for advertising, assessment tools, office materials, etc., then the owner is treating the contractor like an employee.
Type of Relationship: The final criteria is solely based on any written contracts describing the relationship, what employee benefits the contractor is supplied with, the length of relationship, and how important the contractor's services are to the operation of the owner’s overall business.
If it is still unclear whether a worker is an employee or an independent contractor, Form SS-8, Determination of Worker Status for Purposes of Federal Employment Taxes and Income Tax Withholding can be filed with the IRS. The form may be filed by either the business or the worker. The IRS will review the facts and circumstances and officially determine the worker’s status.
If you have questions regarding the correct classification of your employee status, contact me at cmblundell@blundellaccounting.com for additional assistance.