If you “misclassify” a worker and don’t correctly withhold or pay the required amounts, the IRS may flag your business and come after any money owed. You are not an independent contractor if you perform services that can be controlled by an employer (what will be done and how it will be done). What matters is that the employer has the legal right to control the details of how the services are performed. Workers who do not meet these three requirements are either common law employees (category 1, above) or independent contractors (category 2, above). Some of these companies have concluded that it is much less expensive to hire workers as independent contractors rather than as employees. Initially, it’s up to the hiring firm to determine whether any person it hires is an employee or an IC.
- In an attempt to interpret provisions of the Fair Labor Standards Act and discern between employee and independent contractor status, some courts and federal agencies have come up with the “economic realities test.”
- The plumber must pay self-employment tax on the amount of income earned.
- “The biggest problem,” says Miklas, “is that people don’t seek legal advice. They don’t want to know they’re doing it wrong, and when they get caught, they just want to get out of trouble. At that point, you’re just writing a check.”
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- They look at the relationship of the worker and the business and consider the different levels of independence and control within both parties.
- Larger employers must provide their employees with health insurance.
If the employer intentionally misclassified an employee, it can result in significant liabilities. The full amount of income tax that should have been withheld will need to be repaid. Employers also typically provide employees with some sort of health insurance. Health coverage is required for employers with more than 50 full-time employees. This DOL fact sheet on misclassification explains situations in which workers may be misclassified as independent contractors.
Employee vs. independent contractor: Differences you need to know
Employees typically receive employee benefits like insurance, pension, and sick pay, while contractors often don’t. Employees also enter a relationship with their employers for an indefinite period of time, while contractors are typically only employed for the duration of a specific project, or over a specific period of time. Furthermore, those that provide services that are vital to the business’s ability to operate are more likely to qualify as permanent employees. Your responsibility for payment of state and federal taxes, social security tax (FICA), unemployment tax, and employee benefits depends on which of the four categories the workers fall under. The tax liability of an employer is determined by the worker’s employment status.
For both employees and statutory employees, the employer hires an individual and assumes that they personally will be doing the work. For more information about restrictions on industrial homeworkers, see IRS Publication 1026. If the answer to any of these factors is “yes,” the IRS would probably make a case for an employee relationship between the service provider independent contractor vs employee and the service recipient. If the answer to these eight factors is “no,” and the answer to any of the remaining IRS factors is “yes,” there is still cause for concern. Because final determination is made on a case-by-case basis, often in a court of law, it is very difficult to know in advance how a ruling would be made on any specific employer/contractor.
So what’s the difference between an employee and an independent contractor?
A true Independent Contractor is able to assign another to do the job in his or her place and need not perform services personally. TWC uses a 20-point guide to determine if a worker is an employee or an independent contractor. The IRS will let you https://www.bookstime.com/ know when it receives your Form SS-8 and will assign a technician to review the employer employee relationship. During its review, the IRS may request more information from you, and will ask your employer for the same information on your Form SS-8.
Independent contractors arrange and pay their own income tax quarterly, aren’t given any benefits, and aren’t eligible for things like unemployment insurance. The hiring company faces severe penalties if the IRS and/or the courts determine that service providers being treated as independent contractors should be reclassified as employees. If the IRS or other government agency determines that a hiring firm has misclassified an employee as an IC, it can order the firm to treat the worker as an employee and require it to pay back taxes and substantial penalties. Being ordered to pay massive amounts of back taxes and penalties can easily put a small company out of business. Being reclassified is not necessarily great for the worker either–he or she could lose valuable business tax deductions.
Independent Contractor
If you misclassify an employee as an independent contractor, you could have to pay substantial back taxes, fines, and penalties. It is best to get a professional opinion from an attorney or an accountant. IRS form SS – 8 may be used to ask for a determination of status for any individual worker. The IRS uses the information on this form to decide if payroll tax laws will cover an individual. If you pay an IC $600 or more during the year, you must file a form with the IRS to report the payments. Failure to do so will result in severe penalties if the IRS later audits you and determines you misclassified the worker.
Generally, you must withhold and deposit income taxes, social security taxes and Medicare taxes from the wages paid to an employee. Additionally, you must also pay the matching employer portion of social security and Medicare taxes as well as pay unemployment tax on wages paid to an employee. Generally, you do not have to withhold or pay any taxes on payments to independent contractors. With employees, you must withhold income taxes, pay Social Security, Medicare taxes, and unemployment taxes on all wages paid to employees.
How to figure out whether you’re an employee or independent contractor
The penalties for misclassifying employees as independent contractors, or consultants, are severe. During the fiscal year ending Sept. 30, 1989, the IRS began an experimental program under which they examined more than 16,000 business tax returns and subsequently reclassified 76,000 workers as employees. As a result, the IRS generated additional tax assessments of $93.8 million. Ninety percent or more of the companies examined during that 1989 pilot program were found to owe additional taxes. The Internal Revenue Service (IRS), as part of its program to collect the maximum amount of tax owed, has begun to investigate and prosecute cases where individuals are classified as independent contractors.
- But if you’re still unsure, you can file Form SS-8 with the IRS to determine the worker’s status.
- For more information about restrictions on industrial homeworkers, see IRS Publication 1026.
- You may have to pay substantial fines and penalties—and we’re not talking parking ticket type fines.
- Failure to do so will result in severe penalties if the IRS later audits you and determines you misclassified the worker.
- To determine whether a person is an employee or an independent contractor, the company weighs factors to identify the degree of control it has in the relationship with the person.
- In other words, independent contractors don’t have performance reviews, and the business has little say in how they get the job done, so long as it meets the requirements of the assignment.
It does not matter if the employee is called an employee, partner, co-adventurer, agent or independent contractor. The paying company may have to pay back taxes, penalties and interest, unemployment and workers’ compensation liabilities and retroactive fringe benefits. Many companies, small and large, would prefer to hire some, or even all, of their workers as independent contractors. For independent contractors, the hiring individual is not required to make any of those payments. There is typically no protection for employment antidiscrimination or workplace safety laws.
For Charities & Non-profits: Independent Contractors vs. Employees
Below, we outline the difference between an employee and an independent contractor to keep you in compliance with state laws and save you from potentially costly legal fees and penalties. If you determine a worker is an employee, you must withhold income, Social Security, and Medicare taxes from the person’s pay. And you must pay half the Social Security and Medicare taxes due for the employee yourself. You’ll also have to pay for workers’ compensation and unemployment insurance coverage for the employee. If the employer mistakenly or incorrectly defines a worker as an independent contractor, they can find themselves responsible for any unpaid taxes, such as federal unemployment tax. If you classify an employee as an independent contractor and you have no reasonable basis for doing so, then you may be held liable for employment taxes for that worker (the relief provisions, discussed below, will not apply).