TAX TIDBIT: EMPLOYEE VS. INDEPENDENT CONTRACTOR

people in groupWhen businesses require additional staffing, they hire either an employee or an independent contractor. For an employee, the employer is required to withhold Federal and State income taxes, Social Security and Medicare taxes (which must be matched by the employer), and state unemployment/disability taxes. For an independent contractor, all that is necessary is for the entity to report the amount paid during the year to the IRS. As a result, businesses want to classify as many of their workers, as they can, as independent contractors. However, if the IRS determines that you have misclassified your workers as independent contractors, they can reclassify the workers as employees and assess the applicable payroll taxes, which will also generate assessments of penalties and interest for late filing and payment of employment taxes.

Sometimes businesses will misclassify workers as independent contractors, especially if they work part-time or work for a short duration. The IRS position is that if you have right to direct and control how the worker performs the task and have the right to control the business aspects of the worker’s job, that person is an employee. Also, if the worker is paid on a regular periodic basis, rather than when the job is finished, that worker is probably an employee. The permanency of the working relationship is also a very important factor. If the business intends to employ the worker for an indefinite period, they are most likely an employee.

An issue was in the national news recently regarding Uber drivers. California determined that Uber drivers were employees, rather than independent contractors, because Uber had provided smartphones to their drivers, monitored their approval ratings by customers, and deactivated their accounts for unsatisfactory performance. New York, Texas, and Georgia had agreed with Uber’s position that the drivers were independent contractors.

Unfortunately, there is no black and white test as to whether a particular worker is an employee or an independent contractor. However, if you have a case of workers who could legitimately be classified as either independent contractors or employees, you can apply to the IRS for a Private Letter Ruling. State regulations regarding the classification of independent contractors is often more stringent than the tests under federal standards.

If you have any questions about the classification of employees versus independent contractors, please contact us.

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