Many small businesses use 1099 employees, also known as Independent Contractors, to perform work for them. Often times a business owner deems this “easier” than hiring employees directly…..no worry of providing benefits, terminating a contract is easier than having to fire an employee, services can be engaged as needed rather than paying wages consistently, etc. However, the government would much rather have them classified as employees. With the increased use of contract labor and the explosion of the gig economy partnered with the government’s desire to collect tax revenue as quickly as possible, there is continued scrutiny and interest around whether or not workers are classified correctly. Having your workforce misclassified can result in some pretty stiff consequences….do you know if you have it right?
There are essentially 3 things you need to consider when classifying workers….
Remember, all the information in this blog post is published in good faith and for general information purpose only. I am not an attorney, nor do I provide legal advice. The information provided is my personal opinion and not that of any organization, business, company, agency or other individuals. The author is not liable for any losses or damages related to actions or failure to act related to the content of this article. If you need specific legal advice, consult with an attorney who specializes in your subject matter. Any action you take upon the information you find on this website (www.hrraw.com), is strictly at your own risk.
Penny Horton | August 3, 2018
1. Do you have the right to control and direct the work the worker does?
Meaning, are you telling them when and where to work? What tools to use or where to purchase supplies? How detailed is the work instruction you give them? Do you measure how well they are doing the work? Are you providing their training?
2. Do you have the right to direct and control the financial aspects of the worker’s job?
Meaning, if a significant investment in equipment needs made, are you making it? Are you reimbursing the worker’s expenses? Can the worker work for other people besides you? How are you paying them (hourly, weekly, by the job)? Is there a profit and loss opportunity for the worker?
3. What is the status of your business relationship with the worker?
Are you providing benefits of any kind…insurance, savings, paid time off, etc.? How long are they working for you…is it on a per job basis, a set length of time? Are the services they provide a key activity for your business?
The more of these questions you answer in a way that makes the worker seem like an employee, then the more likely the Department of Labor (DOL) or the Internal Revenue Service (IRS) will see them as an employee.
Why does the IRS or DOL care if a worker is an independent contractor or an employee?
The IRS wants workers to be classified as employees because they know employers have an obligation to submit payroll and income taxes on a monthly basis. Since independent contractors only submit quarterly, then this means the IRS would get their money faster. It also means they get more income since the contractor’s, but not employees, are allowed to deduct business expenses. The IRS also has to keep more staff on hand with an increased amount of independent contractors because there are more individual returns to process and more audits to conduct.
The DOL wants workers to be classified as employees so they can make sure the workers get the benefits and protections they are entitled to by law such as minimum wage, overtime, unemployment insurance, etc. and they are also a government agency that wants to ensure they receive as much tax revenue, state unemployment insurance and worker’s compensation funds as possible.
How does the IRS or DOL find out that a worker is misclassified?
Unless the issue is uncovered during some sort of audit or review of another issue with an employer, the most likely way the government finds out is because an unhappy worker lets them know!
For instance…..
Independent contractors aren’t entitled to unemployment insurance (UI) benefits. So if you’ve let someone go and they try to file for UI and realize they don’t get them, they may try to claim they should get them because they really should have been considered an employee all along.
Independent contractors are responsible for paying into a worker’s compensation fund as a self-employed worker. But if they haven’t and get significantly injured on the job they may try to claim they should be covered under their “employer’s” workers compensation insurance.
Individuals who believe they may be classified improperly can also file an IRS SS-8 Determination of Worker Status for Purposes of Federal Employment Taxes and Income Tax Withholding form seeking worker classification. Numerous field audits are conducted by the IRS each year based on these filings.
What happens if I have someone classified incorrectly?
The IRS has the ability to investigate three year’s worth of company’s classification practices and not just for the individual who made the complaint, but for all worker’s the company has used.
If there is an issue of misclassification identified then the IRS can require you to pay all of the taxes as if the person had been an employee of the company, even if the independent contractor already paid the taxes! Additionally, they will add penalties and interest to the amount. Then the IRS will share that information with other stated and federal agencies such as the state tax department, state unemployment office and the DOL who may also want to subject the company to further investigation and review around such concerns as immigration, worker’s compensation liability and federal and state discrimination laws.
How can I make sure I have my workers classified correctly?
Both the IRS and the DOL have a variety of publications, checklists, and questions you can use to help determine the classification on your own. Several are linked below. Or, if you dare you can request the IRS help you determine by submitting a form IRS SS-8.
IRS Independent Contractor or Employee
DOL Fair Labor Standards Act Advisor on Independent Contractors
Bottom line though is, the more it looks like, acts like and seems like an employee, the more likely the government would classify the worker as such.
There are steps you can take to help ensure your contract help seems more like a contractor than an employee. Also, there are exceptions to the classifications and some positions are exempt. Engaging with a professional who is experienced in compliance and classifications can go a long way in preventing concerns and help you ensure your company is protected.
Reality Check
If you aren’t’ completely confident about the classification of your workers, would like a confidential review of your workforce or want strategies to help protect your company, Who’s Your HR? can help!
Who’s Your HR? is available to assist you with HR consulting, contract or project work. Please review the Solutions and Service page or find my contact information in the menu to the left of this article.
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