Good problem to have – Worker Classifications
So many clients are growing their businesses and need help. A common mistake some overwhelmed business owners make is thinking they can choose to make a worker a contractor to avoid paying benefits. What they fail to realize is that the job duties and oversight of the worker control the employee/contractor classification. There is a huge body of law that governs what an employee is, and this area is jointly enforced by the IRS and the Labor Department.
Employees are given workspace and tools. They are told when, where, and how to perform their duties. They are closely supervised and given feedback to improve their work. They must be paid minimum wage, be paid overtime for hours worked over 40, and be compensated for on-the-job injuries. Their salary is recognized on form W-2 to the IRS. The employer withholds taxes and pays certain employment taxes on behalf of the employee.
Contractors are given a scope of work to perform at a certain price at a certain time. They are not told what order to perform the work. They use their own materials. When they are finished, the work is either accepted or rejected. They are not coached or trained. They do not get minimum wage, overtime, paid vacation, workers' compensation, workplace protection from discrimination, or other benefits. Their payments are recognized on Form 1099 to the IRS. No taxes are withheld.
The IRS uses a three-part analysis to determine whether a worker is an employee or an independent contractor (regardless of how the business itself classifies the worker):
1. Behavioral: Does the company control, or have the right to control, what the worker does and how the worker does their job?
2. Financial: Are the business aspects of the worker’s job controlled by the payer? (This includes things like how the worker is paid, whether expenses are reimbursed, who provides tools/supplies, etc.)
3. Type of Relationship: Are there written contracts or employee-type benefits (e.g. pension plan, insurance, vacation pay, etc.)? Will the relationship continue and is the work performed a key aspect of the business?
Generally speaking, the more control you provide over your workers, the more likely they are to be properly classified as an employee. When in doubt, you should classify the worker as an employee.
The stakes are high. Misclassified workers can sue for back wages, overtime pay, and other benefits. If the IRS determines that a worker was misclassified, it may impose penalties against the employer, including a $50 fine for each Form W-2 the employer failed to file on such employee, a penalty of 1.5% of the wages, plus 40% of the FICA taxes that were not withheld from the employee and 100% of the matching FICA taxes the employer should have paid.
North Carolina employers can find the NC Department of Labor’s classification Fact Sheet here.