The classification of workers as employees or contractors is critical. If you classify a worker as an employee, you have to withhold, report, and pay employment taxes, social security taxes, and Medicare taxes. You also have to pay an unemployment tax on the wages.
If a worker is a contractor, the process is more straightforward. Contractors don’t receive any benefits, and they file their own taxes.
Employees receive fixed salaries, benefits packages, and protection in the form of workers’ compensation and severance. Employees also pay payroll taxes on their wages, typically following a work schedule.
Contractors receive compensation for the completion of projects, and do not generally work according to a client’s schedule.
According to the IRS, contractors are self-employed, and they are responsible for their taxes. Contractors also have to pay a self-employment tax.
In practice, classifying a worker as an employer or contractor can be a challenge. The IRS offers three broad criteria to make the classification easier:
The control you have over the worker’s hours and the environment is significant in determining the role of an employee or contractor. If you specify the worker’s hours, provide training, and control their operations, the person is classified as an employee.
If the worker may come and go as they please, with full discretion about how to conduct the job, the worker is a contractor.
If the worker’s input determines their compensation, it is more likely a contractor classification. If the worker receives a salary or wages, they are an employee.
The type of relationship your business has with the worker is significant in determining whether they are an employee or contractor.
If the worker has a standing agreement with the company or if your business is their only source of income, the IRS is more likely to view them as an employee.
How the worker’s activities relate to the core business offer is also significant. If a law firm hires a typist and a computer system installer, the former is more likely to be an employer, and the latter a contractor.
If the IRS finds that you misclassified an employee as a contractor, it may order you to pay back taxes as a penalty.
You can prevent this type of situation with our business consulting service.
Contact the tax experts at MKS&H to schedule a consultation today.