Generally, business growth is accompanied by a higher head count, which in turn is accommodated by growing tax and employee benefit challenges. Many business owners may be tempted to minimize the impact of these challenges by classifying workers as independent contractors rather than employees. However, it is critical that business owners correctly determine the individuals providing services are employees or independent contractors.
Business owners have various statutory obligations arising from wages, including the liability for withholding income taxes, withhold and pay Social Security and Medicare taxes, pay unemployment taxes on wages paid to employees along with various payroll reporting and filing requirements. In contrast, the statutory obligation relevant to independent contractors is very limited and includes the annual preparation and filing of form 1099.
A key factor in the determination of whether an individual providing services is an employee or independent contractor, is the issue of control; accordingly all information that provides evidence of the degree of control and independence must be considered. According to the Internal Revenue Service (“IRS”), the facts that provide evidence of the degree of control and independence fall into three categories: (1) behavioral – the company control or have the right to control what the worker does and how the worker does his or her job; (2) financial – the business aspects of the worker's job, including how the worker is paid, whether expenses are reimbursed, and ownership of the supplies, tools and equipment, are controlled by the payer and (3) the type of relationship – when the type of work performed by the worker represents a key aspect of the payers' business; and the worker provides services exclusively to the non-payer; it is more likely than not the worker is an employee.
It is critical that business owners look at the entire relationship, considering the degree or amount of the right to direct and control the relationship. Additionally, business owners should document the factors used in coming up with the determination.
Inaccurate classification of employees as independent contractors may result in significant costs, as the employer may be held liable for the employment taxes for those employees. However, if there is reasonable basis for inaccurate classification, the employer may obtain partial relief from the associated financial liability, subject to compliance with certain IRS corrective actions, such as participation in the Voluntary Classification Settlement Program, (“VCSP”). Under the VCSP taxpayers are allowed the opportunity to properly reclassify their workers for future tax periods, with partial relief from the federal employment tax liabilities.