BY: KURT M. DETTMER
Business owners are always looking for ways to save costs.
Delivering a superior service or product as inexpensively as possible is always a wise business practice. Sometimes, however, cost saving measures work against a business’s best interest or can even lead to unwanted attention from the IRS, Department of Labor or other government entities. One landmine that can cause a business-owner issues is improperly classifying an employee as an independent contractor, whether intentionally or not.
When evaluating your employee classifications, there are two distinct questions you should consider. First, what are the advantages and disadvantages of classifying an individual as an employee versus an independent contractor? Second, based upon Internal Revenue Service (“IRS”) guidance, are my employees classified correctly?
Classification as an independent contractor or an employee comes with advantages and disadvantages. When engaging with an independent contractor, a business owner will likely see cost savings because they will not be required to withhold income tax or pay social security, Medicare or unemployment taxes. They will also not be required to reimburse employee expenses and will save on administrative expenses such as workers’ compensation premium. However, with the cost savings also comes the relinquishment of control over an independent contractor’s time and their approach to the work. On the other hand, an employee can be required to work certain hours and directed to perform specific tasks at the employer’s direction, while an independent contractor will generally be hired for a specific objective and generally dictate their own hours and approach.
Determining the nature of the relationship is, of course, not as simple as picking one over the other. Rather, the IRS has provided specific guidance to assist businesses in making an appropriate determination. In the vast majority of circumstances, the nature of the relationship is obvious. However, the proper classification can get murky when characteristics of both types of relationship exist.
Readers who have faced these issues before may recall the IRS’s pre-2013 “economic realities” test or the post-2013 “20 factor test” in making a classification determination. These days, while the 20 factor test remains valid, the IRS has broken the factors down into three primary classifications: behavioral control, financial control and the relationship of the parties.
Behavioral control related questions include whether as the employer you control how a worker does his or her work, whether you instruct the worker on when and where to work, what equipment to use, and where to get work equipment from and if you train the worker to complete the work in a specific way. Financial questions include whether you cover business expenses for the worker, reimburse the worker for their business-related expenses or if compensation is directly tied to the completion of a specific task. Relationship questions include whether you provide any benefits to the worker if the relationship is ongoing or has a specific beginning and end date.
For more information about employee classification, www.irs.gov has a lot of useful information. If you are still having trouble determining an appropriate classification, you can also file a Form SS-8 with the IRS and they will make the determination for you.
Finally, it is always a good idea to memorialize the nature of the relationship in writing, whether through an employment offer or independent contractor agreement. While the characteristics of the relationship will ultimately define the classification, a written understanding between the parties will help prevent any confusion or disagreement.