Whether you are an employer who is looking to hire workers for your business or an employee who just got hired, understanding the difference between an employee and an independent contractor can help you to avoid significant tax and legal liabilities.
Usually it is up to the hiring company to determine whether the individual hired is an employee or an independent contractor. Often for companies it is easier to hire an independent contractor than an employee from an economical and legal perspective. Thus, some employers wrongly classify their workers as contractors even though they can fall under an employee classification.
The IRS uses applies a test spanning over three categories to determine worker’s status as an employee or independent contractor. Under each test the IRS will ask questions similar to the following:
1. Behavioral – does the employer control the individual’s schedule?
2. Financial – does the employer pay all business-related expenses on behalf of the worker?
3. Type of relationship – does the employer provide employment benefits, such as health and disability?
If the answer to any of the above is “yes” then additional steps will need to be taken to confirm employee vs independent contractor status. If the IRS determines that an employee is classified as an independent contractor without a reasonable basis it can hold the employer liable for employment taxes for that worker since the hire date in addition to penalties.
The IRS has many programs that can help the employer and employee to avoid tax liabilities due to misclassification. Section 530 Employment Tax Relief provision, for example, provides relief from having to pay employment taxes if a hiring company has a reasonable basis for not treating a worker as an employee. The Voluntary Classification Settlement Program allows taxpayers to reclassify their contractors as employees with partial relief from federal employment taxes. Form 8919 is designed for workers who believe they have been misclassified as independent contractors to report the employee’s share of uncollected Social Security and Medicare Tax due on their wages.