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Business owners, here’s how to classify workers as employee vs. independent contractor

Posted on July 20, 2017

At Teipen Selanders Poynter & Ayres, we realize it can be tricky to accurately classify your workers into the “employee” column versus the “independent contractor” column.

“Complicated, but important,” says Mike Poynter, CPA, “The IRS has 246 specialists who focus on employment tax audits, so using the correct classification will definitely affect your bottom line. There are severe penalties for not remitting ‘trust fund’ withholding taxes when they are due.”

That’s why all our CPAs encourage HR managers and business owners to follow the IRS rules when it comes to classifying a worker as an employee or an independent contractor.

As an employer, you must withhold income, Social Security and Medicare taxes from the employee’s wages and pay these trust fund taxes along with the employers’ portion of payroll taxes. However, if the worker in question is an independent contractor, companies normally do not have to withhold or pay any taxes on compensation paid.

Here are two key points for small business owners to keep in mind when it comes to classifying workers:

  1. Control

If your business controls what work is accomplished and directs how it is done, it exerts behavioral control.

If the business directs or controls financial and certain relevant aspects of a worker’s job, it exercises financial control. This includes:

  • The extent of the worker’s investment in the facilities or tools used in performing services
  • The extent to which the worker makes his or her services available to others
  • How the business pays the worker, and
  • The extent to which the worker can realize a profit or incur a loss
  1. Relationship

How the company and worker perceive their relationship is also important for determining worker status. Key topics to think about include:

  • Written contracts describing the relationship the parties intended to create
  • Whether the business provides the worker with employee-type benefits, such as insurance, a pension plan, vacation or sick pay
  • The permanency of the relationship
  • The extent to which services performed by the worker are a key aspect of the regular business of the company
  • The extent to which the worker has unreimbursed business expenses

Teipen Selanders Poynter & Ayres CPAs understand how to analyze this issue for small businesses. We help businesses of all types navigate this on a regular basis and are happy to help you categorize the status of your workers – to keep your organization on the right side of the IRS.

You can also go to IRS.gov and download form Form SS-8, Determination of Worker Status for Purposes of Federal Employment Taxes and Income Tax Withholding. The IRS also has an excellent publication to help answer your questions. Publication 15-A, Employer’s Supplemental Tax Guide is also available on IRS.gov.