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W-2 or 1099 Employee VS. Independent Contractor Status

  • January 11, 2019 by hamiltontharp
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Today’s workforce is a gig economy. According to a study by intuit, by 2020 40% of American workers will be independent contractors.

Independent contracts can save businesses from the cost of benefits, office space, taxes and many other perks given to employees. Becoming an independent contractor can be very attractive to the individual performing those services as well because of the flexibility over their schedule and the choice in the work they will perform.

Today’s gig economy doesn’t come without implications. Many businesses still employ people and will continue to do so. It’s important to understand the effect of classifying individuals as employees or independent contractors. Many business owners fail to recognize the effect of classifying an individual as an employee or independent contractor. If you have misclassified the individual, you could expose yourself to significant tax liabilities.

As described by the IRS, an employee is anyone who performs services for you where you can control what will be done and how it will be done. Classifying workers as employees requires that a company withhold applicable Federal, state and local income taxes, pay Social Security, Medicare taxes, state unemployment insurance tax and pay any workers compensation fees. Employee status also requires filing a number of returns during the year with various taxing authorities and providing W-2’s to all employees by January 31. Not to mention, employees may also have rights to benefits such as vacation, holidays, health insurance or retirement plans.

Over the years, we have come to learn that there are a number of common myths that you should avoid in classifying your workers. The more frequent inappropriate decisions to classify an employee as an independent contractor include:

  • The worker wanted to be treated as an independent contractor;
  • The organization had a signed contract with a service provider;
  • The worker does assignments sporadically, inconsistently or is on-call to the organization, and
  • The worker is virtual or remote

The IRS notes that simply because a worker does assignments for many companies does not necessarily suggest independent contractor status. The determination of whether a worker is an employee or an independent contractor rests primarily upon the extent that the employer has to direct and control the individual with regard to what and how an activity is to be accomplished. Generally, the employer controls how an employee performs a service. On the other hand, independent contractors determine for themselves how a given assignment is to be completed.

To aid business owners, the IRS has developed tests to be used as guiding points to indicate the extent and direction of control present in any employer/employee/independent contractor situation. The degree of importance of each factor varies depending on the occupation and the facts of the particular situation.

IRS Control Test
1. Behavioral Control 

Employee status is determined when the business can direct and control the work performed by the worker. Consider:

  • Is the individual required to comply with instructions about when, where and how work is to be performed? Receiving detailed instructions may indicate a worker is an employee. Less detailed instructions reflect less control which may indicate the worker is more likely to be an independent contractor.
  • Individuals who are trained to perform a job in a particular method are usually considered employees. Training includes that provided by an experienced worker, requiring the worker to attend meetings or by corresponding with the worker in other methods. Independent contractors bring their skills to your enterprise.
  • Evaluating the details of how the work is done points to an employee while evaluating only the end result can point to either an independent contractor or an employee.

2. Financial Control

If the business can direct or control the financial and business aspects of the worker’s job, it may suggest employee status. Consider:

  • When a worker has a significant investment in his or her own work facilities, this suggests an independent contractor status.
  • An employer generally pays expenses which means it has a right to regulate and direct business activities thereby suggesting employee status.
  • Independent contractors realize a profit or incur a loss. The risk of loss may be the result of investments in equipment or due to other expenses.
  • Generally, you will not see employees market their services to the public on a regular basis.
  • Paying your service provider by the hour, week or month suggests an employee status while paying an agreed-upon lump sum for a job suggests independent contractor status. In some situations, employers may also implement a straight commission basis of compensation without adversely affecting a worker’s status as an independent contractor.

3. Relationship

The type of relationship is dependent upon how the worker and business perceive their interaction with one another. Consider:

  • Is there a written contract which describes the relationship the parties intend to create? Keep in mind, a contract stating the worker is an employee or an independent contractor is not enough to determine the worker’s status.
  • Businesses often provide employees with benefits such as insurance, a pension plan, vacation pay or sick pay. These benefits are rarely offered to independent contractors.
  • An employer-employee relationship is evident if the expectation is set that the relationship will continue indefinitely instead of just for a specific project or defined period of time.
  • Are the services provided considered a key activity of the business? If the worker is a key component of the regular business of the company, it suggests employee status.

In addition, the Voluntary Classification Settlement Program (VCSP) offers certain eligible businesses the option to reclassify their workers as employees with partial relief from federal employment taxes.

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