Employee or Contractor? Do You Know The Difference?
A few months ago, I sat in on a legal presentation where an employment law attorney shared the most costly mistakes his clients made when hiring employees. I was shocked to find out that the majority of these issues revolve around misclassifying employees. Even more shocking? The number of HR departments giving those TERRIBLE directives!
Why Does It Matter?
Misclassifying employees can lead to huge issues that could end up being extremely costly and even shudder your business. These issues can be classified into 3 categories: IRS penalties, legal fees, and reputation issues.
IRS Penalties: The IRS can charge you for missing W2s and wages when you’re found to have misclassified your employees. They will also charge you employment back-taxes for all employee wages and taxes that were unpaid or paid incorrectly.
Legal Fees: Businesses are not only subject to regular court and attorney’s fees if they are found in violation. The courts could also order you to pay back all wages, taxes and other fees and penalties associated with this error. Some companies have even faced criminal charges for misclassifying employees.
Reputation Issues: On top of the monetary costs, many businesses face serious reputation issues after these cases. Many lose clients and customers because most people frown on this type of fraud - whether intentional or unintentional.
Contractor Defined
Generally, an independent contractor is someone hired by a business to perform services, but has more control over various aspects of job performance and execution. Independent contractors will typically provide you with a W-9 when you begin working with them. These information returns give you all the information you’ll need to send them a 1099 at year’s end (as long as you’ve paid them $600+). Independent contractors typically do not get taxes taken out of their pay and are not entitled to company benefits.
Employee Defined
Similar to independent contractors, employees also perform services for your business. Unlike independent contractors, you (the business owner) you more control over how, when and where the work is performed. During the hiring process, employees are required to file a W4 to help you understand how much of their check is withheld for taxes. They’ll receive a W-2 at year’s end. Contrary to independent contractors, employees have taxes deducted from their regular pay and submitted by the business on behalf of the employee.
Testing Factors
The IRS provides a 3-factor test to help you decide whether someone should be classified as employees or independent contractors. The test analyzes the characteristics that the IRS uses to check whether someone would be classified as an employee or an independent contractor.
Behavioral. This refers to the amount of control the business has on how & when the work is completed.
Financial. Who is responsible for supplies and how the worker is paid?
Type of Relationship. Is there a contract in place? Are you providing employment benefits
As you can probably see, these tests can be vague depending on the type of work being done. If you’re stuck, the IRS has Form SS-8 that you can file with them. They’ll help you decide the designation from there.
Some states, like Virginia and California, extend these tests, or have higher penalties for misclassification. This can create more issues when trying to figure out who is an employee and who is an independent contractor.
Do you need help with employee classification? Contact PCVA today for help!
