Independent contractors are becoming increasingly available to business owners for small tasks, sub-contracting of jobs, and as resources to hire without training. But, when prepping for pay and taxes, contractors and employees can often be misclassified.
To prevent misclassification, you should first understand what a contractor is versus an employee. As previously mentioned on our blog,
“Both employees and independent contractors perform services for the company, but the difference is whether the business can control what will be done and how it will be done. An employee for example is hired with the intent that the business has the right to control the details of how the employee’s services are performed. On the other hand, independent contractors are people in an independent trade, business, or profession in which they offer their services to the public. Some examples are graphic designers, consultants, web designers, social media support and virtual assistants.”
Additionally, there are three main factors to consider when determining whether they’re an employee or contractor. This includes the level of control of behavior, relationship, & finances.
If you’re a business owner, knowing the difference may not be enough to easily determine their classification. Here are three steps you can follow to determine whether they are a contractor or employee:
To avoid confusion and possible misclassification, your first step in determining if they are a contractor or employee is to clarify your relationship, method of communication, and instruction. You may do this in conjunction with them or on your end. This can look like verifying contact through email or zoom, if they require training/instruction from you or work independently, or if they’re paid by retainer or hourly and how that payment is processed.
The IRS has a set of rules that can be used to determine if they are a contractor or employee. Testing by this method is called the Common Law Test. This test considers the three factors mentioned before: type of relationship, financial, and behavioral. If the classification is still undetermined, a Form SS-8 can be filed by either the worker or business owner and the IRS will determine their classification.
Miscommunication can be a root cause of misclassification. If they are a contractor, they likely set themselves in that role. To clarify, ask them what they are and if you want them to be considered one or the other, specify which one and what that entails for them and you. It’s important to ensure that you both agree on what they are classified as.
How to Mitigate Misclassification Risks
If an employee or independent contractor is misclassified you run the risk of miscalculated tax returns. This is because an employee will have withheld income, social security, and Medicare taxes from wages paid. Independent contractors do not have withheld taxes and are responsible for their own – not the company. Misclassification can cause underpayment penalties and interest.Connect with a MOD tax professional to ensure your employees and contractors are properly classified in your business.