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October 6, 2010 No Comments

So You Think You Can Make Them Independent Contractors?

You may want to think twice about doing it! 

The Internal Revenue Service has strict guidelines defining the difference between an Independent Contractor and an Employee.  It is estimated that over 3 million workers are illegally misclassified as Independent Contractors.  This is costing the Federal Government an estimated $300 Billion in tax revenue annually due to this misclassification. 

100 New Agents to crack down on small businesses. 

Earlier this year, President Obama agreed to fund an additional 100 IRS agents to assist in cracking down on the misclassification of workers.  It is estimated that this initiative will generate an additional $7 billion in revenue over the next decade for the US Government.  This audit will affect 6000 businesses.  Now is the time to evaluate your employment practices and ensure you have properly classified your workers.

Double Whammy – States join the Feds. 

States are joining the feds in this initiative and are sharing information resulting from audits.  One governing agency conducting an audit can cause a domino effect on the offending business.

Cutting costs illegally. 

Because of the economic times, businesses are looking for all ways to reduce cost.  Many companies are using outsourcing as a way to reduce payroll costs.  This is fine if done legally, however the numbers indicate many businesses are not following the IRS guidelines for proper classification.  Businesses can save as much as 30% of payroll costs by classifying workers as independent contractors.  This avoids paying payroll taxes, unemployment insurance and worker’s compensation payments.  With unemployment at an all-time high, many states have exhausted their unemployment pools and are resorting to assistance from the feds.

Test to determine if you are legal.

 In the past the IRS used a “twenty factor” test to determine whether a worker was an Independent Contractor or an Employee.  In 2006, the test was fine tuned and was reduced to 11 main factors categorized into three main groups; behavioral control; financial control; and relationship of the parties.

Behavioral Control shows whether there is a right to direct or control how the worker does the work.  The worker is an employee when the business has the right to direct and control the worker.  The business does not have to actually direct or control the way the work is done – as long as the employer has the right to direct and control the work.  Examples are if the worker receives extensive instruction such as how, when or where to do the work, what tools or equipment to use, what assistants to help with the work or where to purchase supplies and services.  If these situations exist, the worker is an Employee.  If the business provides training on procedures or methods and that the work is to be done a certain way, the worker is more than likely an Employee.

Financial Control shows whether there is a right to direct or control the business part of the work.  If the worker has a significant investment in the work they do, they may be an Independent Contractor.  If they are not reimbursed for some or all business expenses, they may be an Independent Contractor.  If the worker has opportunity for profit or loss, this indicates there is a viable business and could indicate that the worker is an Independent Contractor.

Relationship of the Parties illustrates how the worker and the business perceive their relationship.  If the worker receives benefits such as insurance, paid time off or pension, the worker is an employee.  If a written contract exists showing the relationship between the business and worker, Independent Contractor status may be appropriate.

Employee Status

When a worker is classified as an employee, the business must withhold income tax, social security and medicare taxes.  The employer is also responsible for their share of social security, medicare as well as unemployment taxes.  Employees are issued a W-2 Wage & Tax Statement.

Independent Contractor

When a worker is classified as an Independent Contractor, the business is not required to deduct or pay any taxes on the worker’s behalf and issues a 1099-MISC, Miscellaneous Income report.  The Independent Contractor is responsible for all payroll taxes both their own income tax as well as the self-employment tax.

Need some advice?

For more information on worker classification, assistance with a determination or a checklist to determine the status of a worker, contact Barbara Flynn, SPHR at People First Inc., www.peoplefirstinc.com.

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