As an employer, it is your responsibility to correctly classify your workers. It’s best to get this right from the very start. If you don’t, there’s a lot at stake and it could come back to haunt you.
“Is this worker an employee or an independent contractor?”
Too often we see employers wait until a question is raised by an employee, agency, or even a lawyer until they worry themselves with this question. By that time it’s much too late.
Get it right from day one.
It will take you extra time, and yes, you might even take on some tax liability for that W-2 employee that you’re not thrilled about, but you need to think long-term. The cost is nothing compared to the penalties and fines you might face later if you get it wrong.
The Difference Between Independent Contractor and Employee
This issue is not as simple as you might think. What you think you know about this may be wrong. The difference may feel like comparing apples to oranges. But misclassifying your workers could lead to some rotten fines from the DOL. Choose wisely, there are pros and cons for each choice.
Who is an Employee?
“A person in the service of another under any contract for hire, express or implied, oral or written, where the employer has the power and right to control and direct the employee in the material details of how the work is performed.” – Blacks Law Dictionary
When you classify your worker as an “employee” you must withhold different taxes and maintain obligations as their employer.
Employees are anyone who performs services that are controlled by their employer. Read the full definition and an example on the IRS website.
With employees, you are required to maintain the following obligations:
- Must provide a base wage or commission-based pay equal to or greater than the federal minimum wage. Or, subject to state/county/municipal specific requirements for nonexempt employees.
- Must track and pay all hours worked for nonexempt employees or pay a salary for exempt employees.
- Must pay the overtime rate of 1 ½ times the base rate for all hours worked in excess of 40 hours per week. Or, subject to state specific requirements for nonexempt employees.
- Full-time employees must also have access to certain health benefits like insurance, vision, and dental care.
- Ensure the employee meets the duties test and salary thresholds if they are given exempt classification.
Employer must abide by the following acts and laws:
- FICA (Federal Insurance Contributions Act)
- FUTA (Federal Unemployment Tax Act)
- FLSA (Fair Labor Standards Act)
- Title VII (Civil Rights Act)
- ADEA (Age Discrimination in Employment Act)
- ERISA (Employment Security in Retirement Act
- ADA/ADAAA (Americans with Disabilities Act)
- FMLA (Family Medical Leave Act)
- NLRA (National Labor Relations Act)
- Applicable State Employment Laws
Employer Tax Burdens
As the employer, you carry the responsibility of withholding the following taxes from your employee’s paychecks and submitting them to the IRS:
- FICA (Federal Income Contribution Act)
- FUTA (Federal Unemployment Tax Act)
- SUI Rates (State Unemployment Tax Act)
- Social Security Tax
- Medicare Tax
- Employee’s Specific Withholding Elections
A few tips to mention:
- Collecting federal or state taxes & remitting those on the employee’s behalf to the appropriate agencies is an additional soft cost labor and accounting expense.
- Tax filing deadlines apply to the employer with penalty and interest exposure if the employer misses the filing deadlines.
- Unemployment claims costs affect an employer’s annual assigned state unemployment tax rate.
- Workers’ compensation premiums are calculated based on an employee’s base wages and are an additional hard cost expense absorbed by the employer.
Who is an Independent Contractor?
A worker who is identified as an independent contractor practices independent employment and can contract with you and/or your business to do work according to their own methods. The independent contractor usually ends their employment relationship with your business once the piece of work or assignment is completed.
You might want to consider some perks of employing workers as independent contractors like reducing your overhead costs and reducing various legal obligations. However, it’s not always that simple…
You must ensure that your independent contractor’s employment status legally qualifies. In the event of misclassification, the IRS can seek back taxes and other contributions that should have been paid on the employee’s behalf. Workers can also seek compensation for job benefits that were denied due to improper classification. And, the DOL can assess fines and penalties against your business.
Play it safe. Do the workers you use really qualify as independent contractors? We’ve run into businesses who classified workers as independent contractors only to have those workers file for unemployment after their assignment ended.
If the state finds that the worker was misclassified, the business is subject to the unemployment claims and may face fines.
The same applies to workers’ compensation insurance. If an independent contractor is injured on the job and claims that he or she was misclassified and meets the requirements to be considered an employee, then you or your insurance carrier may be ordered to pay, and you could be fined for failure to provide workers’ compensation coverage as required by law. There are many other ramifications if you misclassify your workers as independent contractors and they are actually employees. If your workers meet IRS guidelines and are legally considered independent contractors, be sure to cross your t’s and dot your i’s.
How to classify your employees and independent contractors:
These are the tests the DOL and IRS use to determine if your workers are independent contractors. We recommend using the same qualifications.
FLSA 6 Prong Test:
- Extent of work performed by the independent contractor.
- Workers managerial skills affect his/her opportunity for profit or loss of the company.
- Does the worker invest in facilities/equipment?
- What is the worker’s skill and initiative?
- Permanency of the relationship. (ie. Do you work with them every day?)
- Nature and degree of control by the employer.
IRS 3 Prong Test (Darden Factors):
- Behavioral control of the organization over that independent contractor.
- Financial control over them (providing tools, uniforms, vehicle).
- Relationship of the parties.
Beware! This topic is on the Fed’s Radar!
The DOL is strengthening enforcement of these rules by granting funding to 19 states to enhance auditing programs. Nineteen states have been granted an $8.2 million pot to split and enhance misclassification auditing programs. The DOL, EEOC, and IRS are aggressively auditing employers.
Notice: This information is not to be considered as legal services and is not designated to replace legal services.