Karyn Richardson, CPA •
Determining what to classify an individual who provides services to your business is sometimes a slippery slope. Business owners often prefer to have as many independent contractors as possible – no payroll taxes or benefits to pay, and no employment and labor laws to follow. Individuals may want to be considered an employee to have access to benefits and legal protection. Per the IRS, the general rule is “that an individual is an independent contractor if the payer has the right to control or direct only the result of the work, not what will be done and how it will be done”. Sounds clear and concise, but what does control really mean?
Determining what to classify an individual who provides services to your business is sometimes a slippery slope. Business owners often prefer to have as many independent contractors as possible – no payroll taxes or benefits to pay, and no employment and labor laws to follow. Individuals may want to be considered an employee to have access to benefits and legal protection. Per the IRS, the general rule is “that an individual is an independent contractor if the payer has the right to control or direct only the result of the work, not what will be done and how it will be done”. Sounds clear and concise, but what does control really mean?
The IRS has developed a “20 factor test” that helps business owners classify these individuals appropriately. The test is broken down into three major categories – behavioral control, financial control, and relationship between the parties.
Below are the major factors to consider in each category:
Behavioral control:
Financial Control:
Relationship:
To complicate things even further, each state has their own rules when it comes to classifying workers. The State of New Hampshire considers all workers employees unless they meet all seven points of the Department of Labor’s criteria.
It is important not to ignore this issue. The IRS and many states have cracked down in this area, and it is an issue that is often examined during an audit. There have been lawsuits brought on by individuals who feel they were misclassified as independent contractors when that individual is trying to collect unemployment compensation. There are some pricey consequences if you have misclassified an employee as an independent contractor. You are subject to employment taxes since date of hire, and will certainly be assessed interest and penalties on these taxes. If you believe you currently have a classification issue, the IRS has a Voluntary Classification Settlement Program that allows qualified businesses with partial relief from these federal employment taxes.
If you have answered yes to any of the above criteria questions when evaluating your current independent contractors, this individual may be an employee, and the relationship should be reviewed using the entire list of factors listed in IRS Publication 15-A, or calling your tax professional as the list is extensive and sometimes may be a judgement call.
Below are the major factors to consider in each category:
Behavioral control:
- Do you as a business owner have the right to control what work is performed by the individual?
- Are you training the worker on how to do the job?
- Are you giving specific, detailed instructions on how to do the job?
Financial Control:
- Have you purchased significant equipment for the individual?
- Do you pay this individual a guaranteed amount on a specific weekly or regular basis?
- Is this individual not allowed to provide services to other business concurrently while he/she is providing services to you?
Relationship:
- Do you provide employee-type benefits, such as insurance, pension plan, vacation or sick pay to this individual?
- Will this individual provide services to you indefinitely?
- Are the services provided a key activity of the business?
To complicate things even further, each state has their own rules when it comes to classifying workers. The State of New Hampshire considers all workers employees unless they meet all seven points of the Department of Labor’s criteria.
It is important not to ignore this issue. The IRS and many states have cracked down in this area, and it is an issue that is often examined during an audit. There have been lawsuits brought on by individuals who feel they were misclassified as independent contractors when that individual is trying to collect unemployment compensation. There are some pricey consequences if you have misclassified an employee as an independent contractor. You are subject to employment taxes since date of hire, and will certainly be assessed interest and penalties on these taxes. If you believe you currently have a classification issue, the IRS has a Voluntary Classification Settlement Program that allows qualified businesses with partial relief from these federal employment taxes.
If you have answered yes to any of the above criteria questions when evaluating your current independent contractors, this individual may be an employee, and the relationship should be reviewed using the entire list of factors listed in IRS Publication 15-A, or calling your tax professional as the list is extensive and sometimes may be a judgement call.
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