Since the economic downturn began in 2008, companies have been creatively looking to “trim the fat” when it comes to expenses. The recession, coupled with increased business regulations and health care reform has led businesses to continue expense-minimization efforts.
One way this has been achieved is by classifying workers as independent contractors rather than employees. The cost advantage of this is that you aren’t responsible for providing them with certain perks (healthcare benefits) and you don’t have to pay employment taxes on their wages.
But because this is a way of avoiding certain taxes, this is something that is highly monitored and regulated by the IRS. We all know that Uncle Sam needs his money and that the IRS is there to ensure that businesses are giving their just due to the government.
With that being said, companies found to be misclassifying their employees are leaving themselves open to receive a hefty civil fine of up to $25,000 per event PLUS potential back employment taxes.
So how do you know if you’re misclassifying your employees? Here are the three factors that the IRS uses:
- Behavioral Control – to what extent do you control how the worker performs the work? If you are directing how work is accomplished, providing training, giving instructions, etc. the worker may be seen to be an employee. This factor is all about asking how much autonomy does the worker have and how much are you controlling the “who, what, when, where, and how” of his work.
- Financial Control – to what extent do you control the financial aspects of the work? If you are purchasing the tools necessary for the work to be done and/or reimbursing the incurred expenses of the worker, the worker may be seen to be an employee. Likewise, the IRS looks to see if the independent contractor is able to realize profits or losses in the performance of duties. If the worker can incur no losses, he/she can be viewed as an employee.
- Relationship of the Parties – how do the parties view the relationship? Here the IRS looks at how permanent the relationship is, if the worker receives any benefits (i.e. insurance), and what business relationship was intended (as shown by written contracts).
These three factors are all taken into account and the IRS looks at the whole situation to determine if a worker is an employee or independent contractor. Being aware of the test the IRS uses can help you in avoiding the misclassification of workers and the penalties that comes along with it.