Deciding how to classify a new worker can be considered one of the most basic HR or payroll decisions. It can also be considered one of the most important.
This decision affects the employer’s tax and reporting requirements...
For an employee, employers must withhold federal income tax, social security tax, Medicare tax, state income tax and local income tax from each paycheck. And the company must pay its fair share of social security and Medicare taxes and make federal and state unemployment insurance contributions on their behalf.
For an independent contractor, withholding is not required. Independent contractors provide the company with a Taxpayer Identification Number (TIN). The company does not withhold or match social security tax or Medicare tax on the payments for services provided by an independent contractor. The employee and employer social security and Medicare taxes are paid by the independent contractor as self-employment taxes.
It also affects the employer-employee relationship…
For an employee, the employer has control over what work will get done as well as how it will get done.
For an independent contractor, employers can only direct or control the result of the work completed. They have no control over exactly what will be done and/or how it will be done.
Generally, an employee is someone you plan to hire full-time and permanently (they get a W-2 form), while an independent contractor is someone you bring on specifically for project-based work (and gets a 1099 form).
The IRS has a guide to help employers determine how to classify their employees. It’s called the Common Law Test. The test looks at three major factors…
- Behavioral - Does the company control or have the right to control what the worker does and how the worker does his/her job?
- Financial - Are the business aspects of the worker’s job controlled by the payer? (This may include things like how the worker is paid, whether expenses are reimbursed, who provides tools/supplies, etc.)
- Type of relationship - Are there written contracts or employee type benefits (i.e., pension plan, insurance, vacation pay, etc.)? Will the relationship continue and is the work performed a key aspect of the business?
For more information on the Common Law Test and how to properly classify a worker, see this article on the IRS’ website.
However, if you’re still confused, that’s okay. There’s something called an SS-8 form that can be completed (by either the employee or the employer) and filed with the IRS. Upon receipt, the IRS will review and officially determine the worker’s status.
Click here to download an SS-8 form.
No matter which classification you choose, making the right decision is important because it not only sets the tone for the proper employer-employee relationship, it also prevents you (the employer) from being subject to misclassification fines from the IRS.
Got a question? Contact us. One of our payroll and labor law experts would love to help you!