Employee or Independent Contractor? Classification Matters

Understanding the difference between an employee and an independent contractor is an important part of running your business.

It can be tempting to classify someone as an independent contractor because it may seem simpler or less expensive, but worker classification is not a choice you can make based solely on convenience. The IRS looks at the actual working relationship to determine whether someone is an employee or an independent contractor.

How Does the IRS Determine Classification?

The IRS generally looks at three areas:

Behavioral control: Who determines when, where, and how the work is performed?

Financial control: Who controls the business aspects of the work, including expenses, tools, equipment, and opportunities for profit or loss?

The relationship: Are benefits provided? Is the relationship expected to continue indefinitely? Is the worker performing a key part of your business?

No single factor determines classification. The IRS considers the entire relationship.

Common Signs You May Have an Employee

A worker may be more likely to be considered an employee when:

• You set their schedule and require specific working hours. 
• You provide the tools, equipment, software, or supplies they need. 
• You train them on exactly how to perform their work. 
• They work primarily or exclusively for your business. 
• They perform the same ongoing duties as your employees. 

These factors don't automatically make someone an employee, but they are important to consider when reviewing the relationship.

A Contract Doesn't Determine Classification

Simply putting "independent contractor" in a contract—or paying someone with a Form 1099-NEC—doesn't make them an independent contractor.

The IRS looks at what is actually happening in the working relationship, not just what the paperwork says.

Why Getting It Right Matters

If a worker is incorrectly classified as an independent contractor, your business could potentially owe back payroll taxes, interest, and penalties. You could also face issues involving state payroll taxes, unemployment taxes, workers' compensation, overtime, minimum wage, or employee benefits.

The costs can become significant, especially when multiple workers have been misclassified or the issue has continued for several years.

When in Doubt, Get Help

If you're unsure how to classify a worker, don't wait until an audit or worker complaint forces you to address the issue.

The IRS provides resources to help businesses determine worker classification, including Form SS-8, which can be used to request an IRS determination. Eligible businesses may also be able to use the Voluntary Classification Settlement Program (VCSP) to correct certain worker classification issues.

Worker classification is an area where being proactive can save your business significant time, money, and stress.

If you pay independent contractors, take a few minutes to review those relationships and make sure the classification matches how the work is actually being performed.

If you'd like help gaining a clearer picture of classification, contact Affordable Bookkeeping & Payroll Services(opens in new tab) at 310-534-5577 or contact@abandp.com. We’d be happy to help! 

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