A common question we have heard from employers is how do I determine if a person I hired should be considered an employee or an independent contractor. It is important to classify the individual correctly, as there can be significant penalties assessed by the IRS if a worker is classified incorrectly.
Here is an article released by the IRS on this subject:
An employee is generally considered to be anyone who performs services, if the business can control what will be done and how it will be done. What matters is that the business has the right to control the details of how the worker’s services are performed. Independent contractors are normally people in an independent trade, business or profession in which they offer their services to the public. Doctors, dentists, veterinarians, lawyers, accountants, contractors, subcontractors, public stenographers or auctioneers are generally independent contractors.
Independent contractor vs. employee
Whether a worker is an independent contractor or an employee depends on the relationship between the worker and the business. Generally, there are three categories to examine:
- Behavioral Control − does the company control or have the right to control what the worker does and how the worker does the job?
- Financial Control − does the business direct or control the financial and business aspects of the worker’s job. Are the business aspects of the worker’s job controlled by the payer? (Things like how the worker is paid, are expenses reimbursed, who provides tools/supplies, etc.)
- Relationship of the Parties − 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?
Other considerations when classifying an individual: does the individual supplies his or own materials, equipment and / or tools? Does the individual define the hours of service?
Misclassifying workers as independent contractors adversely affects employees because the employer’s share of taxes is not paid, and the employee’s share is not withheld. If a business misclassified an employee without a reasonable basis, it could be held liable for employment taxes for that worker. Generally, an employer must withhold and pay income taxes, Social Security and Medicare taxes, as well as unemployment taxes. Workers who believe they have been improperly classified as independent contractors can use IRS Form 8919, Uncollected Social Security and Medicare Tax on Wages (.pdf) to figure and report their share of uncollected Social Security and Medicare taxes due on their compensation.
Voluntary Classification Settlement Program
The Voluntary Classification Settlement Program (VCSP) is an optional program that provides taxpayers with an opportunity to reclassify their workers as employees for future tax periods for employment tax purposes with partial relief from federal employment taxes for eligible taxpayers that agree to prospectively treat their workers (or a class or group of workers) as employees. Taxpayers must meet certain eligibility requirements, apply by filing Form 8952, Application for Voluntary Classification Settlement Program, and enter into a closing agreement with the IRS.
Who is self-employed?
Generally, someone is self-employed if any of the following apply to them.
- They carry on a trade or business as a sole proprietor or an independent contractor.
- They are a member of a partnership that carries on a trade or business.
- They are otherwise in business for themself (including a part-time business).
Self-employed individuals generally are required to file an annual tax return and pay estimated tax quarterly. They generally must pay self-employment tax (Social Security and Medicare tax) as well as income tax. Self-employed taxpayers may be able to claim the home office deduction if they use part of a home for business.